USE PUT OPTIONS TO OFFSET POTENTIAL LOSSES IN YOUR STOCK PORTFOLIO
Posted by Chad Shoop | Mar 19, 2019 | Trading Strategies, Winning Investor Daily
You’ve probably heard the notion that buying at the right price is everything.
If you pay a cheap price for the stock, the rest takes care of itself.
And that is important.
But anyone who has ever sold a stock knows that the price you pay is only half the battle.
Knowing when to sell is the other half.
If you sell too early, it will haunt your investing decisions for years to come. I don’t want that to happen to you.
I want to show you a way to avoid this critical decision altogether.
By following this strategy, you’ll never have to sell your stocks at a loss again. And you’ll continue to reap the rewards as the stock keeps soaring.
I know it sounds impossible.
After all, if this strategy exists, why doesn’t everyone do it? The truth is that not everyone knows about it. And the few people who do know about it don’t take the time to understand.
I’ll explain this all to you today in fewer than 900 words…
3 SELECTIONS TO MAKE FOR THIS STRATEGY
Now, if you haven’t heard about this strategy, or you have but you haven’t implemented it yet, it’s not your fault.
Brokers and other media outlets make it seem more challenging and riskier than it really is. Most brokers will even require you to fill out a separate application to add this trading strategy to your account — but it’s more than worth it.
The way to never take a loss again is by using options on stocks you already own. More specifically, it’s using put options.
In my premium service Pure Income, we use put options in ways that I won’t get into today.
But if you have a portfolio of stocks, and you aren’t using put options, you are missing out on an enormous opportunity to never take a loss again.
You can use what’s called a protective put option.
A protective put option is when you buy a put option on a stock you already own. The put option represents a contract between you and the seller of that option.
To find an ideal protective put option, there are three key selections you’ll have to make:
- Use a strike price (a price at or just below the current price) as the line in the sand for your position. Think of this as where you would normally exit to preserve capital or lock in profits.
- Set an expiration date (how long the contract stays open). When selecting this time frame, it really depends on your view. Think of it as buying time to see if the stock turns around. I usually go out three months to assess the stock and allow the company to release another earnings report.
- Pay attention to the price. This is how much the protective put option will cost. The less you spend, the better. And sometimes you can spend a lot less by waiting a day or two before placing the trade.
One more important note: Keep in mind that one options contract covers 100 shares of a stock. So, buy one protective put option on a stock that you own at least 100 shares of. Then for every 100 shares you own, you can buy an additional put option.
Here’s an example of how it played out in my Pure Income service…
THIS STRATEGY TURNED A 20% LOSS TO A 4% GAIN
We owned shares of Boyd Gaming, a casino operator, in October 2018. The stock fell, and we were down over 20%. I was ready to exit.
But I never just exit a stock. I buy a protective put option on it instead.
The put option limits my downside risk to the strike price and the price I pay. It doesn’t matter how much lower shares fall before the option expires — that’s the most I have at risk. The put option rises in value as the stock falls — offsetting the stock losses.
Once I bought the protective put option, there were only three possible outcomes from this trade.
- Outcome No. 1: The stock keeps falling. If it’s below the strike price when it expires — March 15, 2019, in the case of Boyd Gaming — the shares sell at the strike price instead of the current price.
This is not the outcome I recommend. It would still result in roughly a 20% loss for the position.
- Outcome No. 2: The stock, again, falls below the strike price. When it is set to expire, I close out the put option for a significant gain.
Then I add this gain to my overall stock position to lower my cost basis. And I can add another protective put based on the stock’s current price.
This is where the real power of the strategy comes in.
With the gain from the first protective put, I lowered my cost basis. Even though the stock fell 40% overall, thanks to my put option, I’m down about 20%.
And when the stock rebounds, I can get back to a profit at a price well under my original buy price.
- Outcome No. 3: This is exactly what happened with Boyd Gaming. Since we purchased a protective put option instead of exiting at a 20% loss — which most people would do to preserve capital — the stock had time to rally.
Shares climbed over 30% after we added the protective put option. It allowed us to exit the trade, including the cost of the protective put, with a 4% overall gain.
It might sound like a lot of work just to get back to breakeven or for a slight gain, as was our case. But not having to take that steep loss made it worth our patience.
During this volatile market, when you are thinking about exiting to preserve capital or pocket gains, remember that you have a third choice — protective put options.
Chad Shoop, CMT
Editor, Automatic Profits Alert