Put options help to insure your stocks, providing unlimited potential for profits while the most you would be able to lose is the premium paid.
No one wants to have a tree fall on their home, or walk out of the grocery store to find someone has hit their car and run off. But when that does happen, we have insurance to cover the losses. Home and auto insurance allows us to sleep at night, knowing that if a disaster hits, we’ll be able to withstand the financial consequences.
Though not many people realize it, there’s a way to get similar insurance and peace of mind on your investment portfolio—through put options.
Options have an admittedly bad reputation, and it’s true that if you don’t know what you’re doing, trading options can be risky. But with a little education on the subject, options trading can be as safe as you want it to be. When done right, the whole point of options is to reduce risk. Options are all about probabilities, which enable you to choose your level of risk in a given trade.
[text_ad]
Put options give the buyer the right to sell 100 shares at a fixed price (strike price) before a specified date (expiration date). Likewise, the seller (writer) of a put option is obligated to purchase the stock at the strike price if exercised. This gives the buyer unlimited potential for profits while the most they would be able to lose would be the premium they paid.
For example, the purchase of the XYZ 100 put for $1 would only risk the $1 paid. If the stock were to close at $100 or above at expiration, the put would expire worthless. If the stock were to go below $99, the holder of this put would make $100 per contract purchased per point below $99.
What Do Put Options Really Do?
Put options help to insure your stocks. By purchasing a put option, its guarantees that your stock will not sell below the strike price if you decided to sell.
And this is very beneficial because if your stock was to experience a substantial decrease in price, the put option would protect you from severe loss. Put options also give the buyer the right to sell the stock at the strike price to the seller of the put option (who is obligated to buy if you exercised this option).
On the contrary, if your stock experiences increases in price, then you can just let the put option expire. In this scenario, the buyer would just simply pay the seller the premium.
Final Thoughts On Put Options
Overall, put options are a great way to safeguard your portfolio from loss. They are especially beneficial to more conservative-leaning investors as the most you are able to lose is the premium you paid. Put options aren’t meant to protect your portfolio from minor dips, but if you expect one of your stocks to dramatically decrease in price, they’re worth considering. You will be glad you did in the long run.
To learn more about options trading, consider subscribing to Cabot Options Trader, headed up by veteran options trader and chief analyst Jacob Mintz.
[text_ad]
What do you find most confusing about put options? Share your thoughts in the comments.