USING PUT OPTIONS TO PROTECT YOUR STOCK HOLDINGS

I own a house. Every year I purchase an insurance policy to protect against unexpected damage or total loss of house. My expectation and hope is that I will never have need for benefits afforded under policy, but I pay premiums nonetheless.

Just as you would insure your house by buying an insurance policy, you can buy a put option to insure your stock positions against unexpected loss. When you buy a put option, you have right to sell your stock at a defined price for a defined period of time. If your stock holdings fall in value, a put option will permit you to sell those depressed holdings at pre-defined strike price.

Consider example of a stock purchase we used above. Let us assume that you bought call option and you decided to take ownership of stock because you believed that it would continue to appreciate. You already have an $8 profit, and you want to protect it against loss so you buy a $40 strike price put option for a cost of $1.50 per share. If stock continues to rise in value, you will have no need for your put option and it will simply expire worthless, just as your home owner’s insurance expires at end of policy term. If something unexpected occurs in market, causing your stock to drop in value, your position is protected against loss because you will be able to sell your stock at pre-defined strike price of $40 per share.

PROFITING WITH PUT OPTIONS

When a trader expects a stock to decline in value, she might sell stock short. Selling stock short requires a significant amount of capital and exposes you to significant risk if market rallies to new highs.

Put options can also be used to profit from anticipated market declines. You can buy a put option in expectation of market losing value. By buying a put option, you are only required to pay cost of option. There is no margin requirement. Your risk is limited to amount you paid for put.

Assume your stock dropped from $40 to $30, and you had paid $1.50 per share for a put option with a $40 strike price. Your maximum risk on trade would be $1.50 you paid for put option. That put option would now be worth at least $10, since you have right to sell a $30 stock for $40 per share. Your profit would be a minimum of $8.50, which represents a 560% profit.

Conversely, assume stock gapped up at market open to $45 per share. Your risk on put option is limited to $1.50 per share that you paid, while short-stock trader has incurred a $5.00 per share loss.

PROFITING NO MATTER WHICH WAY A STOCK MOVES

Perhaps you do not know whether a stock will move up or down, but you do believe it is likely to make a significant move in one direction or another. A stock trader is at a loss, because she does not know whether to buy stock or sell it short. As an option trader, it is possible to profit by using an option strategy such as a straddle.

A straddle involves simultaneous purchase of both a call and a put option. Assume your stock is trading at $30 per share and you expect that it will make a large move, but you are not sure whether it will be an upward or downward move. You decide to buy a call and a put for a combined price of $3.50 per share. If stock makes a large move to upside, your call will gain value and your put will lose value. If stock moves to downside, your put will gain value but your call will lose value. Because maximum loss is limited on both call and put, there is a finite value by which either can decline while providing unlimited profitability on other side.

If stock makes a large upside move to $45, your call will be worth a minimum of $15 per share. You paid $3.50 for combined put and call, so your minimum profit would be $11.50 or a return of approximately 329%. In event of a large downside move to $20 per share, put would have a minimum value of $10which would produce a minimum profit of $6.50 per share or a return of 186%. These returns are possible while risking no more on trade than that combined amount paid for call and put option.

MORE LIMITED RISK OPPORTUNITIES

This article is by no means intended to be a comprehensive exploration of options or option strategies. What this article attempts to demonstrate is that options can be used without significant financial risk. In fact, options are effective tools for limiting your risk in market and, if properly used, are much less risky that stock investing.

For stock investor, options provide an opportunity to protect positions against loss and enhance returns. Speculators can participate in market without exposing themselves to large risks. Anyone actively investing in market or who is considering such investments would do well to educate themselves about benefits offered by options.

An opinion adopted by many is to consider social security in part closer you are to retirement. For example, if you are sixty years of age and plan on full retirement in five years, you should consider an analysis based on your current projected benefits. Even with proposed reform plans, preservation of benefits is a priority for eligible citizens age 50-55 and older.

If however you are thirty, it may be better for you to omit such projections. The result will be overfunded personal savings. Thus social security will be an added benefit and not benefit.

Consider troubling issues of 2004 OASDI Trustees Report: future scheduled benefits for today's young workers could be reduced by 27% or more if amendments to current plan are not adopted.

Young workers should take note of this report. Do not rely on social security and concentrate on personal savings.

In conclusion, you have a risky option—there is only one way to justify social security, don't save for retirement. If this is your chosen route, be prepared for difficult times ahead.