A Simple Options Technique To Quell Market Worries

The markets, which are at or hovering around all-time highs, may make a trader/investor hesitant to put on a position.

One may have some gains in a stock they wish to protect or would like to put on a position with minimal risk. This simple put strategy may help to keep traders in or allow a put on a trade with confidence for the short term.

The trade involves simply buying a put, generally out to the next expiration cycle. A trader may go out longer if it makes sense for the position.

See also: How Strangling Your Options Trades Will Help You Sleep At Night

Let’s take a look at a few examples to see how this works.

A trader may be bullish on oil or oil stocks. Take Newfield Exploration NFX, currently trading at $28.19 per share. Concerns that the market or oil cloud could drop may affect the position, and allow traders to then buy the APRIL 2014 30 put for about $2.80. 

Buying the put gives the trader a chance at unlimited gains while limiting the loss below four percent.

The put has about 47 days to expiration giving the trader time for the stock to move.

Let’s break this down and see how it works.

Purchase of NFX stock:               $28.19

Purchase APRIL 2014 30 put:    + $2.80

Cost basis:                                $30.99 (cost of stock and put)

Breakeven:                                $30.99

If the stock continues to go up, the trader profits on any price over the breakeven at $30.99, giving a chance at unlimited profits.

Even if the stock drops to zero during the April cycle, the trader can exercise the put on the stock at $30, gaining $1.81 on the stock purchase.

However, the put price adds to the cost basis here and must be factored in.

Cost basis:                  $30.99

Strike price of put    -  $30.00

Loss :                      -  $.99 (so $.99 (loss)/$30 strike or price of stock) = about a 3.3 percent loss)

A trader or investor can then purchase a stock with a minimal loss, but unlimited upside above the breakeven. Try to look for a situation that limits the loss to under four percent.

You may also own a stock with a nice gain so far and this strategy could help to lock in a certain amount of profits.

Here is another example with Unisys UIS.

The stock recently tried to break to new highs but has backed off a little. A trader may want a position for a run up but with limited chance for a loss.

Let’s take a look.

UIS stock purchase:         $34.22

APRIL 2014 35 put :     +  $2.00

Cost basis:                      $36.22  (cost of stock and put)

Breakeven:                      $36.22

So

Cost basis:                      $36.22

Strike price of put        -  $35.00

Loss :                             -1.22 

So $1.22 (loss)/$35 strike price of stock if exercised) = about a 3.5 percent loss.

Consider this technique the next time before purchasing a stock, but are concerned about a stock or market drop near term.