With market
volatility being high over the past few years investors are starting to see the
value of using protective puts as part of there every day trading strategies.
The
rewards can be great from investing in highly volatile stocks such as technology
and bio- tech stocks, but the risk is also greater. By adding put options to
your strategy you can be better positioned for any direction the market may
take.
The
strategy is fairly simple and inexpensive for the insurance value received. For
every 100 stocks you buy, buy one protective put contract one or two strike
prices below the current market price. If
you buy a stock for $35 you would buy the $32.5 or the $30 put, so that if the
stock price plummeted you can sell the stock for close to what you paid for it.
If
the stock jumps you will participate in the upswing less the amount you paid for
the protective puts. Thus, the put acts as an insurance policy.
Example:
Looking at The Walt Disney Company (DIS) trading at $19. It would take $1900 to
buy 100 shares. If you buy the shares your downside risk, is theoretically
$1900, with a potentially unlimited upside reward. By buying one protective put,
which covers all 100 shares, you limit the amount you can lose should the stock
drop in price.
If
the stock moves higher you might want to roll up your option. This is done by
selling off the original put and buying another put at a higher strike price
thus locking in profits and increasing you downside protection.
Using ShareCharts
Option Strategies for Protective Puts the entire transaction can be seen
clearly. Go to Derivatives < Option Strategies and select Protective Put from
the ‘Strategy’ Drop Down Box. Enter in all relevant parameters and click
‘Update’ to view the chart.