Buying Insurance For Your Stock

Did you know there was a way to buy insurance for your stocks?  It allows you to keep some of the money you have invested if your stock crashes, which could be very powerful when times are uncertain.

It works by utilizing something called a put option.  When you buy a put option on a stock you are buying the right to sell your stock at a certain level on or before a given date.

So, say for example you buy a stock trading at $46 and decide that you want some protection to the downside.  You can buy the $40 put option 6 months out for $5.  Now if the stock crashes you will be able to buy the stock at, at least $40 within the next 6 months.

So, let’s go through every scenario.

1.       The stock Goes up

If the stock goes up to say $70 within that 6 month period you will have profited and the put you bought will expire worthless.   You may choose to buy another put again if you believe the markets are still uncertain or if you would like to insure some of the profits you have already made.

2.       The stock goes down a little or stays Flat

If the stock stays flat the option will eventually expire and you can decide what to do next.  You will not have to exercise your put, and can decide to buy back the option to reclaim some of your premium.

3.       The stock Crashes

If the worst case scenario happens, the stock gets cut in half and is now trading at $23.  If we had just bought and held the stock we would have lost $23, however because we bought the $40 out we can exercise our right to sell the stock at $40.

This strategy is called a protective put and can save us from the majority of a loss if things turn against us.

For more on the protective put strategy visit http://www.stocks-simplified.com/protective_put.html