How Put Options Can Make You Money In A Down Stock Market

If you have worked hard to build up a stock portfolio over the years you have certainly experienced times when you’re nervous as to what the future holds regarding the stock market generally. Especially after having a nice run-up, you can almost feel the market is due for a pullback. Even if it’s not going to be a major trend reversal into a bear market, during these times you have probably thought to yourself that it would be nice to protect some of the gains that you have earned.

Rather than just adopting a “wait and see” attitude and hoping for the best, why not be proactive and consider buying put options as a way of hedging a part of your portfolio? Understanding stock options basics takes a little effort, but the idea with options is that you can use a relatively small amount of money to establish a position where you will see outsized gains from a move compared to simply buying shares or shorting stock. While leverage has its risks, one benefit with options is that the most you could ever lose is the premium that you pay.

With disciplined, prudent purchases of put options, if you do see the drop in the market that you expect, the losses that you will experience only on paper in the stocks in your portfolio can be at least partially offset by gains in the put contracts that you buy. In a perfect world you would take the gains that you experienced from your puts by selling them, at a point before the market starts to rise again.

One problem with stock options is that new investors are inclined to put way too much money into them, risking more than they really should. Most investment professionals advocate that no more than 5% or so of your entire investment portfolio be invested in options, and even then only after you have had put options explained adequately to you. In any case, education is never a bad thing, and sooner or later you will encounter a situation where a little bit of well-placed leverage will, as they say, go a long way.

This stock market investing post was a guest post from one of my readers. For more articles by Ty Coon check out my series on buying stocks.