Do you wish to buy "insurance" for your stocks to prevent their values from dropping?
Yes, you can with a simple options strategy called "Protective Put"!
Protective Puts is an option trading hedging strategy used to hedge against a drop in stock price. Protective Puts are very similar to Married Puts and is a popular option trading strategy amongst stock traders. Protective Puts protect your stock's unrealised profits, so that you don't have to sell any shares to lock in the profits so far.
Without stock options, the only way a stock trader can protect unrealised profits on shares is to liquidate (sell) a part of the holding. However, liquidating part of the holding denies the stock trader access to future profits should the stock continue to do well. Option trading solves this dilemma using Protective Puts.
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Protective Puts is simply buying at the money put options whenever you wish to "lock in" your share's profits. Once the Protective Put is in place, the put options will appreciate in step with any depreciation in the stock price, hedging against any losses completely.
Protective Put Example :
Assuming you own 100 shares of XYZ at $40 and it appreciated to $60. Now, the only way you can guarantee that $60-$40 = $20 profit is by selling your shares, right?
Now, if you sell your shares, what if the price of XYZ continues to go higher? Won't you have missed out on the profits? This is when you can simply buy 1 contract of XYZ $60 strike price put options in order to buy "insurance" for your XYZ stock at $60!
Assuming XYZ company got hit by an unforeseen scandal and its stock price drops from $60 to $10. Even though you would lose $60 - $10 = $50 x 100 shares = $5000, your put options value would actually rise to $60 - $10 = $50, making you a $50 x 100 = $5000 profit, completely offsetting the $5000 loss on the stocks, thereby insuring you against the loss and protecting the value of your portfolio.
Now, put options are not free. Put options comes at a fraction of the price of the stock, known as a "Premium". You pay a premium for insurance even if it is not used, right? That's exactly the same for Protective Puts. You pay the premium on the put options exactly as you would pay an insurance premium. If the price of the underlying stock continues to rise, the put options expires out of the money eventually when its "contract period" is over, incurring the cost of the put options as expense, exactly like an insurance plan.
How much is the "premium" on a put option? For instance, GOOG (Google Inc.) closed at $823.31 (27 Jan 2017) and its January $822.50 put options are trading at about $13.00, which is only 1.58% of the value of the GOOG stock itself. So, just paying 1.58% of the value of the stock buys you complete protection against GOOG dropping below $822.50 for a month! In fact, if you could take a bit of risk, buying the protective put at the $800 strike price only cost about $6, which is only 0.7% of the value of GOOG's stock! A small fee for a huge protection!
|You could also create the same profit/loss profile as Protective Puts using only a fraction of the money involved in the Protective Puts by using another option trading strategy known as the Fiduciary Calls. This means that Protective Puts actually creates synthetic long call positions. But this won't work if you are really using Protective puts in order to protect your stocks.|
Protective Puts is a simple option trading strategy where you simply buy to open 1 contract of at the money put options for every 100 shares that you own.
What if you own less than 100 shares of the underlying stock?
Good news is, there are now Mini Options on most of the most heavily traded stocks that represent only 10 shares instead of 100 shares. So if you own just 10 shares of the underlying stock, even if its slightly lesser than 10 shares, you could simply buy 1 contract of its Mini put options instead.
What if you owned quite a few different stocks instead?Well, if you own quite a few different stocks in a single portfolio, you could actually try to hedge the portfolio as a whole by buying put options on the ETF that most closely represent your portfolio, be it QQQ for Nasdaq, DIA for the Dow or SPY for the S&P500.
Following up from the above example:
Assuming XYZ rises to $60 by the expiration of the Put options. Assuming the put options cost $1.00
Profit = ($60 - $40 - $1) x 100 = $1900
Following up from the above example:
Breakeven = $50 + $0.80 = $50.80
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