2 Ways for Nervous Investors to Hedge With Options

A protective put is purchased on shares you already own

Managing Editor
Feb 15, 2024 at 1:53 PM
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    Wall Street has seen decent gains so far in 2024, thanks in part to earnings, inflation data, and an overall boost in investor sentiment. However, as we know, all chips can be on the table -- and lost -- with just one steep selloff when it comes to trading options. For when things are looking a little too good to be true, or warning bells are starting to ring, below are a couple of ways nervous investors can hedge their bets with options. 

    Protective Put

    protective put is purchased on shares you already own, typically at an out-of-the-money strike. The protective put acts as "insurance" in the event of a severe pullback on the stock.

    Specifically, if the underlying equity tanks and breaches the put strike within the option's lifetime, the shareholder can sell the stock at locked-in price (the strike) for more than what he or she would receive on the market. However, this is not to suggest protective put buyers don't want to see their stock rally; the puts are bought as a source of security to limit his or her losses in the event of a worst-case scenario. 

    Collar

    Another hedging technique for tepid investors is called a collar. A collar is simply a protective put partially or fully paid for by a covered call. Because of the sold call -- typically written at an out-of-the-money strike -- the collar is a riskier method of "insurance" for a stock you own.

    A collar is riskier than a lone protective put because the shares could be called away on a rally above the sold call strike. Therefore, if the stock is one the trader definitely wants to keep, he or she should consider following through with only a protective put, particularly during times when the underlying's options are attractively priced.

     

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