Insuring profits

If you own stock you have one option to protect your profits, sell your position. If you learn how to use options you can use a PUT instead. Here is how a put works, if you BUY A PUT, you create downside protection, the PUT allows you to sell stock at a pre-determined price regardless of how much it has declined. If you bought apple at $160 per share and now it’s $380 per share you can buy a PUT, granting yourself the options to sell shares at $380 even though it has dropped to $350. This is not free, you pay a percentage of the price to protect your downside, however you give yourself downside protection. If you just sold your stock you could lose the upside if the market rises, and you may create a large capital gain. Think of the PUT as insuring against loss, using a percentage of your profit to protect the remaining shares. The PUT works just like homeowners insurance, only if a event occurs you use the benefits you bought. If the stock does not decline your PUT will be worthless.

The Bank

If you have ever played blackjack, you know you play against the bank. The bank usually wins. You may win on a particular night but overall the odds are in favor of the bank. This is also the case with options. If you want to be the bank you need more capital then being the player, however you acquire the better odds. Let me give you an example. When you sell a call you must deliver stock at a set price. When you buy a call you are investing a smaller amount of money, in hopes that you can turn your smaller investment in to a greater return. The call seller owns the stock, lets say 100 shares of apple at $350.00. The seller has invested $35,000 where as the call buyer puts up a fraction of the stocks value in hopes of the stock moving in the positive direction. The call buyer puts 100% of their investment at risk, but the call seller limits his upside. Now two thirds of the time the bank wins in these situations. So again, do you want to be the bank or the player?