Protective Puts, Why are they useful?

Protective puts allow you to protect yourself from huge losses in the stock market when times are uncertain.  So what are they?

When you buy a protective put you are buying the right to sell a stock at a given price on or before a given date.  So say you own a stock that is trading at $60 and are not sure if the company will go down or not. 

You could decide to buy the $50 put 6 months out for $3.  This way if the stock crashes within that 6 month period you will be able to sell it for at least $50.  So if the stock falls to $40 you will be able to sell it for $50, if it falls to $30 you could still sell it for $50, ect.

Of course you don’t have to sell it at $50, if the stock stays above that level you can just let the put expire worthless, or buy it back.

Basically buying protective puts is like buying insurance, if the worst case scenario happens it is helpful, if it doesn’t just forget it.

So how can you use this strategy to your benefit?

1.       To Limit your losses on long term plays

You can use it to limit your losses in the market and protect you from taking huge losses by buying insurance on your long term investments.   This would have helped many investors out there.

2.       You can use them on covered calls.

If you also sell calls on the stock you can potentially make up the money and profit still.  If you sold 1 call a month and made an average of $1 per call not only would you have limited your losses, but you would have also made $6 in call options which would have more than paid for the protection.

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