NISM-Series-VIII: Equity Derivatives · Strategies using Equity Futures and Equity Options

Covered Call, Protective Put and Hedging with Options

Updated 11 October 2026 · Fact-checked

A covered call means holding a stock and selling a call on it to earn premium, which caps your upside. A protective put means holding a stock and buying a put, which sets a floor on your loss. To solve questions, find the stock P&L, add the option P&L, then read the break-even.

Understand Covered Call, Protective Put and Hedging with Options

Most option strategies in the exam combine an option with the stock you already own. The stock gives you the main exposure. The option changes the shape of your payoff.

A covered call is: long stock plus a short call. You receive the premium. If the stock rises above the strike, the call buyer exercises and your gain on the stock stops at the strike. If the stock falls, you lose on the stock, but the premium cushions the loss a little. You use it when you expect the stock to stay flat or rise slowly.

A protective put is: long stock plus a long put. You pay a premium. If the stock falls below the strike, the put gains and offsets the stock loss, so your loss is limited. If the stock rises, you keep the gain minus the premium. It works like an insurance policy on your holding.

A collar is: long stock, long put (lower strike) and short call (higher strike). The call premium received reduces the cost of the put. Your loss and your gain are both limited to a band. A collar is cheaper than a protective put but gives up upside.

The main contrast to remember: a covered call limits profit and gives only small downside protection. A protective put keeps unlimited profit potential and limits loss, but it costs money. Both are used to hedge or to enhance returns on a stock you already hold.

Key formulas to remember

Covered call: net payoff at expiry: Payoff = (ST − S0) + Premium received − max(ST − K, 0); S0 is the purchase price of the stock, ST the price at expiry, K the call strike.
Covered call: maximum profit: Max profit = (K − S0) + Premium received; Reached when ST is at or above K. Profit is capped.
Covered call: break-even: Break-even = S0 − Premium received; Below this price you make a loss. Maximum loss = S0 − Premium (if the stock falls to zero).
Protective put: net payoff at expiry: Payoff = (ST − S0) − Premium paid + max(K − ST, 0); K is the put strike.
Protective put: maximum loss: Max loss = (S0 − K) + Premium paid; Applies when ST is at or below K. If K is below S0 the loss is still limited. Profit is unlimited.
Protective put: break-even: Break-even = S0 + Premium paid; The stock must rise by the premium before you profit.
Collar: profit and loss limits: Max profit = (Kcall − S0) + Call premium received − Put premium paid; Max loss = (S0 − Kput) − Call premium received + Put premium paid; Kput is the lower strike and Kcall the higher strike. Net premium can be a small credit or debit.

How to solve Covered Call, Protective Put and Hedging with Options questions

Use the same method for any stock-plus-option question. Work per share first, then multiply by the lot size if asked.

1Identify the stock position (long or short) and the purchase price S0.
2Identify each option leg: bought or sold, call or put, strike and premium.
3Write the premium as a cash flow: received for a sold option, paid for a bought option.
4Take three price zones: below the lower strike, between the strikes, above the higher strike. Work out the stock P&L and option P&L in each zone.
5Add the stock P&L, the option payoff and the net premium to get the total P&L in each zone.
6Find the break-even: the price where total P&L is zero. Then identify the maximum profit and maximum loss.
7Multiply by the lot size only if the question asks for the contract or total amount.
8Check the answer against the shape: capped profit means a short call is involved, floored loss means a long put is involved.

Quickest way: Shape and break-even shortcut

When to use it: Use this for theory-style MCQs and for quick numerical questions with one strike.

Short call on the stock means the profit is capped at (K − S0) + premium.
Long put on the stock means the loss is floored at (S0 − K) + premium.
Covered call break-even = S0 − premium. Protective put break-even = S0 + premium.
A covered call is a bullish-to-neutral view. A protective put is a hedge for a holder who fears a fall.
A collar = protective put paid for partly by selling a call. Both ends are limited.

Common mistakes in Covered Call, Protective Put and Hedging with Options

Saying a covered call gives unlimited profit.
Students remember that the stock can rise without limit and forget that the short call gives away the gain above the strike.
Fix: Remember: the short call caps profit at (K − S0) + premium.
Adding the premium for a protective put instead of subtracting it.
Students treat any option premium as income.
Fix: Premium on a bought option is paid, so it reduces profit and raises break-even to S0 + premium.
Using the wrong break-even direction for a covered call.
Students copy the protective put rule, S0 + premium.
Fix: Premium received lowers your cost, so covered call break-even is S0 − premium.
Thinking a covered call protects fully against a fall.
The word 'covered' sounds like safety.
Fix: The protection is only the premium received. Losses below the break-even continue until the stock reaches zero.
Ignoring that the put strike affects the maximum loss.
Students assume protection starts from the purchase price.
Fix: Loss is limited only below the strike. Maximum loss = (S0 − K) + premium, so a lower strike means a larger loss but a cheaper put.
Confusing the collar legs.
Both a call and a put are involved, and the strikes are easy to swap.
Fix: The put is bought at the lower strike for protection. The call is sold at the higher strike to fund it.

Worked examples

Example 1

You buy a stock at ₹500 and sell a call with strike ₹520 for a premium of ₹12. What are the maximum profit and the break-even per share?

Show the solution

Strategy: long stock plus short call, so it is a covered call.
Premium received = ₹12 per share.
Maximum profit = (K − S0) + premium = (520 − 500) + 12 = ₹32.
Break-even = S0 − premium = 500 − 12 = ₹488.
Check: at ST = ₹520 the stock gains ₹20 and you keep ₹12, giving ₹32. Above ₹520 the call is exercised and profit stays ₹32.

Answer: Maximum profit is ₹32 per share and break-even is ₹488.

Example 2

You hold a stock bought at ₹800 and buy a put with strike ₹780 for a premium of ₹15. What are the maximum loss, the break-even and the profit if the stock is ₹850 at expiry (per share)?

Show the solution

Strategy: long stock plus long put, so it is a protective put.
Maximum loss = (S0 − K) + premium = (800 − 780) + 15 = ₹35.
Break-even = S0 + premium = 800 + 15 = ₹815.
At ST = ₹850 the put expires worthless. Stock gain = 850 − 800 = ₹50.
Net profit = 50 − 15 = ₹35.

Answer: Maximum loss is ₹35, break-even is ₹815 and profit at ₹850 is ₹35 per share.

Exam tips

Expect questions that ask which strategy suits a given view. Covered call suits a flat or mildly bullish view. Protective put suits an investor who owns the stock and fears a fall.
Read whether the option is bought or sold before you compute anything. Many wrong answers come from swapping the premium sign.
Check the options for 'profit unlimited' and 'loss limited'. This pair identifies a protective put. 'Profit limited' with a premium inflow identifies a covered call.
With negative marking, skip a calculation question only if you cannot fix the strike and premium. Otherwise the three-zone method is quick and reliable.
For collar questions, state the net premium first. It is the call premium received minus the put premium paid.

Practice questions from Strategies using Equity Futures and Equity Options

Covered Call, Protective Put and Hedging with Options in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Covered Call, Protective Put and Hedging with Options: frequently asked questions

What is the difference between a covered call and a protective put?

A covered call is long stock plus a short call. It earns premium but caps profit. A protective put is long stock plus a long put. It costs premium but limits the loss and keeps the upside open.

Why is it called a covered call?

The call you sell is covered by the stock you already own. If the buyer exercises, you can deliver the stock instead of buying it at a higher market price.

When should you use a protective put?

Use it when you want to keep holding a stock but want a floor under your loss, for example before a result or a period of uncertainty. The cost is the premium.

What is a collar strategy?

A collar combines a long stock position, a bought put at a lower strike and a sold call at a higher strike. The call premium helps pay for the put. Both profit and loss are limited.