Put options can be used as an insurance policy to protect stock holdings. As a good rule of thumb, when you buy stocks, you should buy put options. This is called a “married sale.” You must buy enough put options to cover your long stock position. (Remember, a sales contract gives the holder the right to sell 100 shares of the underlying stock, at the strike price, before the expiration date.) By buying put options, you minimize the potential loss of a stock, should it go down in price.

For example. You buy 1000 shares of Acme Company at $77 and ten puts of 70, one month before expiration, for $1. By purchasing the put option, you increased your investment in the Acme Company to $78. The philosophy of a risk averse trader is this: if it’s not worth paying an extra $1 to lock in this position, it’s not worth being in! If the action with protection is not worth paying $78 for, it is also not worth paying $77 without it. You are buying the Acme Company because you think the stock is going up. If you don’t think you will at least increase the cost of the put in the time remaining until the put expires, you have the wrong stock! This is a bullish strategy, why own a stock if you are not bullish? And why own protection posts? Just in case you’re wrong. You don’t think your house will burn down, but you still buy insurance, right?

It is important to understand, of course, that buying married puts is not a cure for underperforming stocks. If you own a stock that doesn’t go up, why do you continue to own it? Sell ​​it and buy another along with married options to cover it. With matched puts, you need to be confident that the stock will rise in price and also be willing to give up a small upside gain to offset your downside risk protection. When buying put options, you set the maximum loss on the stock at the put option strike price, less the put option cost. In our example, you are guaranteed $69 per share (the put strike price of 70 minus the $1 premium paid for the put option) even if it hits zero before expiration.

When you buy a put option, you are buying the right to sell the stock at the strike price, less the cost of the put option. If your stock goes down, you can sell the put and buy a put with a lower strike price for the next month. If the stock reverses and rises, you can participate in the rise, less the cost of the put, while letting the insurance policy (the put) expire. Rather than risk a market downturn, you buy a put option to protect your position or profit. When you have a big profit and think the stock can still go higher, buy the put options anyway so you can sleep easy at night.

Maximum Loss: The difference between the price you paid for the shares and the strike price of the put option, plus the cost of the put option and commission.