Portfolio Protection Step 5: Put Options

In my recent article 5 Steps to Protect Your Portfolio , the final step I
discussed was utilizing put options as insurance that any unrealized gains you
have don't turn into losses. Most investors have heard of options but often
think they are just for rich folks or hedge-fund managers, who employ them for
speculative purposes. Certainly, sophisticated investors regularly use them as
leverage to maximize their portfolio gains. But they also like to use options
such as puts to nail down their gains and to mitigate losses should their
stocks' prices head in the wrong direction. In essence, put options provide
protection by betting that the underlying stock will decline. They give you the
right (not the obligation) to sell the stock at a certain price at a specific
future time. There are three scenarios in which a put can help you protect your
portfolio: Protect Unrealized Profits Let's pretend you own 100 shares of
Intel (NASDAQ: INTC ), which closed yesterday at $26.71. The stock has had a
nice run this year, up from its 52-week low of $19.16. If you had bought those
shares at the low, you would be sitting on a gain of about 39% today not too
shabby for a very volatile market! And while you might think the shares have
more momentum in the short term (like I do), so you don't want to sell them
right now, you also know any whiff of trouble from Europe or other bad economic
news could send the market and Intel's fortunes downhill. That's when
buying a protective put can help mitigate your potential loss. First, you buy
one put option from your broker, which gives you the right to sell 100 shares of
INTC. If you are very risk-averse and decide you want to protect your current
gain, you can buy a put option that allows you to sell INTC at a price of $26
through July 20, 2012. (Note: There are many options available, depending on
your time frame. Read more about Intels options here. ) As of Jan. 24, this
particular put will cost you about $202, plus commission. If the price of INTC
continues climbing, you will be out the $202 you paid for the option, but you
will reap the benefit of the price increase in your INTC shares. But if the
price of INTC stock declines under $26, you can still sell it at that price,
through July 20. Bottom line: You have locked in your gain!