Many traders buy and hold stocks through their respective ups and downs. Only ever making money on the way up and getting nervous when they go down. There is a way to protect your stock. You can buy a long put option. The long put option acts as an insurance policy for your stock. The long put option gives you, the buyer of the option, the right to sell your stock at a fixed price within a set time frame.
Let’s say you own 100 shares of XYZ stock and is trading at $100/share ($10,000 investment). You buy to open a long put option with 4 months of time value. You will have to pay a fee for buying this option. The cost of this long put option is $500.00 to protect the 100 shares you currently own. If the stock were drop to $60 per share on bad news (example: earnings report) you would have the right to sell your stock at $100 (the price at which you purchased your option) even though the stock is currently trading at $60/share, provided you do so before the long put runs out of time. You’ve proctected your portfolio from losing $40/share x 100shares = $4,000! The only amount of money you will lose is the price you’ve paid for that long put option which was $500. So, which sounds better to you… a $4,000 loss or a $500 loss? What if you had owned 500 shares… $20,000 loss or $2500 loss? At this point the decision is easy.
I’ve tried to keep the above example pretty basic. A long put is nothing more than an insurance policy when used with a long stock position. There are many investors out there that say options are too risky for the average investor. My response to that is…as opposed to the above example were you could lose thousands upon thousands of dollars. Or better yet, how about Enron and Worldcom to name a few. You need to understand anything before you engage it. Once we understand how to protect our hard earned money, trading the stock market can be a lot more fun and profitable. This will be my first installment of a basic Option strategy. I’d appreciate feedback and/or questions regarding this article. I appreciate your time and make it a great day!