Protect Yourself With Put Options

Mon, Nov 22, 2010

Investment

Hi NeedMoneyers,

In previous posts, I’ve discussed protecting yourself against inflation, identity theft and against the ramifications of not having a sufficient emergency fund. Now, I’d like to discuss ways to protect your stock portfolio against market declines. For those of you who have long time horizons for your stock holdings, protecting your portfolio becomes less necessary seeing you have time on your side. However, those owning a large amount of stocks in their investment account who might need the money within the next few years need to seriously consider ways of protecting against a sharp market decline (as happened in 2008) right at the point where you need to sell stocks to generate cash. If the timing goes against you and you are faced with liquidating positions in a bearish market, then this could end up costing you a significant amount of money. Trust me, I’ve experienced this — unfortunately — myself.

When rebuilding my financial life I became quite conservative, and I was hesitant to even own a single stock. A smart investor shared with me the strategy of “married puts” which serves as an insurance policy against market declines in the near or mid-term future. This strategy entails purchasing a put on the same stock owned in your portfolio. When you do so, you limit your lost to the strike price of the put purchased. True, you are giving away some of your profits by the expenditure to buy these protective puts, but the peace of mind is well worth it. Next, we’ll discuss covered calls as a similar options strategy aimed at defending against risk. See everyone soon,

James

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