Using Puts To Make Money In A Bear Market

Obviously no one knows if the market is at the beginning of a new bear market phase for the stock market, but one thing is for sure: if you would like to hedge yourself against the possibility that July 2011 marked the beginning of a downtrend, stock options–specifically put options–offer many opportunities for protecting yourself against losses. In this article Stock Options Explained will cover the simplest one of all: simply buying puts on stocks that you own.

Investors and short-term traders often attempt to use the outright purchase of put options to make money in a bear market or to protect their stock investments against potential losses. Either way, one favorable aspect of purchasing puts is that your risk is Continue reading Using Puts To Make Money In A Bear Market

Options Trading Explained-Writing Options

This is the second article of our options trading explained series, in which I will attempt to help you learn options trading strategies as opposed to restricting myself to a generic explanation of stock options. In the earlier post I explained stock options trading in terms of simply going long, or buying, puts and calls as the simplest but most risky of stock options strategies. In this article I’d like to talk about selling or writing options as it opens up a range of possibilities for an investor to improve the overall performance of his portfolio.

When you move beyond thinking of options only as leveraged, risky investment vehicles you begin to understand them as savvy investors and professional traders do, ripe with opportunities for conservative option strategies. There are many ways to use them besides either making multiples of the premium you pay or losing most or all of that premium. I’ll cover options trading examples like writing puts and calls, which affords you hedging options (as it were) that can help you protect existing gains in open stock positions; you could sell options to create an ongoing income from your portfolio without having to sell stock at all; you can even offset losses in stock positions you are not yet prepared to close out, by writing contracts against those long or short positions. All these trading strategies involve simple options selling, and these are just a small fraction of the ways that you can use these incredibly versatile investment tools, once you get stock options explained to you.

Writing Options As A Simple Hedge

Let’s say that you have a nice profit in a stock that you would prefer not to sell yet. Maybe it’s had a run-up recently, and while you are still bullish on the company, your practical side tells you that the stock might very well be due for a pullback.

In addition to the optimism reflected in the stock price, it seems like the options associated with the stock have relatively pricey premiums, with even the out-of-the-money options costing more to buy than they normally might.

For an investor contemplating buying options, this is a risky situation. If you bought, or went long calls here, not only would the upward stock move have to continue, the volatility in the stock has to stay relatively high, or you will see time value decay eat away at the value of your long calls. Let me be clear: Continue reading Options Trading Explained-Writing Options

Hedging With Options

If you have been getting stock options explained to you via this stock options guide, it should be pretty clear by now there are many ways to use options that do not involve increased risk, that in fact serve to reduce overall risk in our portfolio. In a nutshell writing calls and puts usually gives us this ability. In the largest sense, writing options is about hedging, taking the safer side of a transaction in which the person on the other side of the trade is achieving leverage.

As leverage (such as one can achieve by buying calls and puts) is all about making huge gains on a usually smallish amount of money, hedging (e.g. with options) is about achieving rather small percentage gains on (usually) existing positions that are often quite large. If my aim is to explain stock options basics then I must cover both sides of options transactions- the buy (long) side and the sell (short) side.

Hedging can be a better strategy than simply holding a position and being fully exposed to a possible price downturn. Farmers use the commodity markets to ensure that they get a certain price for at least a portion of their crop, guarding against possible lower prices for a not-yet-harvested crop.

We can do this with stock options by selling someone a right to purchase something we own at a higher price, with the stipulation being that if the market never takes the price that high, by a certain date, that we keep the money that we got for selling that right in the first place.

With stock options you can create an income by selling calls with a strike price higher than the current price of the stock, against shares that are already in your portfolio. If you’re not ready to sell your stock in a given company at its current price, but would be happy to sell it at a higher level, simply write a call for each 100 shares of stock you own, with a strike price at which you would be satisfied to sell. In this way, if your shares continued to rise and the price is higher than the strike at expiration, your call will be exercised and you will deliver the shares at the strike price. If your shares are not priced above the strike price at expiration, the calls that you have written will expire worthless and you will simply keep the premium amount that you received for writing them (as well as your shares, of course). Many, many savvy investors with large portfolios make nice rates of return in this way, against stock that they are still bullish on, but could be persuaded to sell at higher levels. The downside of this strategy is that as you are obligated to sell at the strike price, assuming the call is in the money at expiration, you would miss out on any further rise in the price of the stock beyond the strike price.

The concept is exactly the same with puts incidentally, except reversed: for stock that you are short and still bearish on, but interested in hedging, you could write a put contract for every 100 shares that you are short and would like to include in the position, puts with a strike price at which you’d be satisfied in covering your short shares. If at expiration the stock is above the strike price the puts will expire worthless and you will keep the premium, and if this stock price is below the strike price, you’ll simply be forced to cover the applicable shares at the strike price.