Hedging a Long Stock Position with Puts

Hedging a long-stock position with put options is a common risk management strategy used by professional traders to protect against potential downside losses while still maintaining upside exposure. For those who have not protected their downside risk since Donald Trump’s tariff policy, there’s still time to protect yourself against further market declines.  

This technique involves purchasing put-options on equities you already own.  A put option gives the holder the right to sell the underlying stock at a predetermined set price (the strike price) within a specific time frame (usually a maximum of 9 months). This strategy is often referred to as a "protective put."

The strategy is like buying insurance for your home.  If the stock price falls below the strike price of the put, the investor can exercise the option and sell the stock at the higher strike price, thereby limiting the loss.

Let’s look at a simple example: an investor bought 100 shares of ABC stock in 2023 for $20/share and the stock rose to $100/share in March 2025 (an $80 gain).  The Trump tariffs, however, forced the stock to decline to $75/share, and the investor fears further losses.  The investor could buy a “protective put” on the position at $75/share for a couple hundred dollars.  If the stock falls to $20/share, the investor could exercise the put and sell the stock at $75/share (the strike price) – guaranteeing a $55/share gain on the position, less the cost of premiums.  

On the other hand, should the stock reverse the short trend and head back to $100/share, the investor loses the premiums paid (pennies on the dollar) and makes back the $20/share loss.  In this case, the investor lets the put option expire.  One key advantage of this approach is that it allows the investor to remain in the position and benefit from any future upside in the stock. Unlike selling the stock to avoid risk, protective puts offer downside protection while keeping the long position intact. However, the cost of the put option (the premium) can reduce overall returns fractionally, especially if the stock does not decline.

Protective puts are particularly useful during periods of market uncertainty or when nearing key events like earnings announcements or economic reports. While not free, this strategy offers peace of mind and a clear exit plan in adverse scenarios. In summary, hedging with puts is a flexible and effective way to manage risk in a long equity position without giving up the potential for gains.

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