When you are holding assets that you are reluctant to
sell, but you are bearish on the market, you can buy puts
as a hedge to help protect yourself against a market
If you are holding a diversified portfolio and you feel it
is vulnerable to a market decline, you could buy index
puts to protect the whole portfolio. Select an index that
best represents your portfolio. If you are holding a
particular asset that you feel is vulnerable, you might buy
puts on that asset.
If you are correct about the market decline, the losses
you incur from the decline in your assets will be offset by
the gains made by the increase in value of the puts.
When you establish your position, you can make the
appropriate calculations to determine the number of puts
to purchase to approximately offset your portfolio.
With this strategy, your profits are unlimited (but
decreased by the premium you paid for the puts). Your
losses are limited because the losses on your assets are
offset by the gains in the puts.
When you feel confident in the market again, you can sell
your puts if they still have value. If the market is still
vulnerable when your puts expire, you will have to decide
whether to purchase more puts.
It is important to analyze your expectations for the
underlying asset and for the market before selecting your
When you are analyzing potential option positions, it
helps to have a computer program like Option-Aid that
swiftly calculates volatility impacts, probabilities,
statistics, and other parameters of interest. These
programs can pay for themselves with the first trade that
they help you with.
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