Options can be used to generate extra income like in this cash secured put example, but can also be used to protect a stock holding from a large drop in price.
A put option is a financial contract that gives the holder the right, but not the obligation, to sell a certain underlying asset at a certain price on or before expiry.
For this right, the buyer of the put option pays a premium to the option seller. Think of it like buying insurance against your house burning down.
You as the homeowner pay the insurance premium and the options seller is like the insurance company.
Owning a put option gives the owner the right to sell their stock at a certain price, no matter how low it goes. The downside is protected while the investor still gets to benefit in the upside.
Protecting Your Boeing Stock
Let's look at an example.
Boeing stock is trading right around a 221.33 buy point, and today we'll look at how you can use put options to protect an investment in BA stock.
With Boeing stock trading around 220, traders could buy 100 shares of the stock for $22,000.
Buying a Sept. 15 put option with a strike price of 210 will cap any losses below 210. It doesn't matter if Boeing stock goes to zero — any losses below 210 are protected.
That September 210 put option is trading around $7.70, which would cost $770 to buy a block of 100 shares. That's just like paying your house insurance premium. You pay the premium to be protected from the worst-case scenario.
Buying some protection like this can be expensive, but allows us to rest easy knowing the maximum loss is capped in the event of a market correction.
Boeing Stock Put Option Part Of Risk Management
Put options can help protect against large price declines and are an important risk management tool for investors.
Check out IBD's new OptionsTrader app for options education, trade ideas and more! Download from the Apple App Store today.
It's important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
