Protect your New Stock Purchases
Let’s use the same scenario. But say you just purchase 100 shares of INTC for the first time today and you want to protect your money. You do the same thing — buy a put option with a July 20, 2012, expiration with a strike price of 26 (your purchase price). Again, the cost will be $202. If the stock goes below $26, you still can sell it at that price. And if it rises, you don’t have to do anything; just enjoy your gains!
Protect Current Holdings That Have Declined in Value From Further Downside
Now let’s say you bought 100 shares of a stock that has fallen in value, from $30 to $25 per share — a loss of $500), and you are willing to hang in if it falls another couple of dollars, to $23 per share, but you don’t really want to lose any more than that. You can buy a put option — let’s estimate that cost at $200 — that will allow you to sell your shares at $23 (your strike price), even if they fall below that level. Although you are already in the red by $700 at this point, the put limits further downside loss. And if the shares go up, you can sell your put to recoup all or part of that cost, retaining your actual shares. And, of course, if your shares rise enough, you might cash out with a gain!
You see, buying puts is not that complicated at all!
And there’s more good news! You don’t have to limit your protection to just individual stocks; you can also employ index puts to protect your entire portfolio. And of course, there are lots of choices, corresponding to the broad indices, as well as sector indices. They work essentially the same way — protecting your portfolio against broad market or sector declines.
Using puts to protect your portfolio can be money well spent, and can be economical, in the long run. Investors are beginning to realize they also are not as complex as they originally thought, and have begun ramping up their use. Discount broker ETrade (NASDAQ:ETFC) recently reported that 20% of its trading volume is now in options. And at brokerage firms whose customers are primarily traders, that volume can reach more than 40% of their trades.
While there are plenty of very complex options, most investors will do well by simply using put options for portfolio protection. And in volatile markets like those we currently are experiencing, it might be well worth your while — and your money.