Options Basics: Why Use Options?

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One would have had to know the exact moment to buy, and then to have held on ever since. Do you know anyone like that? Perhaps you are one of them. In that case you face a pretty high-class problem — how to lock in at least a large part of those gains, but still participate if the market continues even higher. And to a degree we can, by using options.

This could be individual stocks or exchange-traded funds. Some of the choices apply to mutual funds as well. With this choice, we keep the stock holdings, except for a fraction that we sell to raise cash to buy insurance on how to use options as insurance rest.

The stock of Apple Inc. Given the beta of each individual stock, ETF or mutual fund in your portfolio, you can easily calculate a portfolio weighted-average beta. For example, a portfolio that had equal dollar value how to use options as insurance in each of the above four stocks would have a portfolio weighted-average beta of 1. Buying 10 puts on SPY would approximately hedge our portfolio. At that time, the cost of options was at a near-all-time low, so the cost of puts was attractive.

Insurance for longer periods is also available by choosing puts that expire farther in the future. Purchasing puts would be one effective way to hedge our portfolio value at a fairly reasonable cost. If you wait until the market actually begins to drop, the price of puts will be much higher. Note that mutual funds have readily available beta readings too. If you have a substantial amount of money in mutual funds in your IRA, k or other pension fund, you can calculate their equivalents and insure them with puts as well.

Using puts as insurance is just one way that listed options can be used by smart investors. Disclaimer This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk.

The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different how to use options as insurance the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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