Stock Options - How to Insure You Shares Against a Market Crash

You wouldn't buy a car or a house and risk losing all the money you had invested should you be the victim of theft or experience a natural disaster such as fire or would you?

It makes perfect sense to the average person to make sure they have an insurance policy in place to protect them from any potential losses. Even though we have to pay a premium for this protection, it gives us peace of mind doesn't it?

Something that scares the average person away from Investing in the Stock Market is the fact that they may lose all their money in the event of a Stock Market Crash.

But did you know you can actually pay a premium for an insurance policy on Shares you own?

It is called a Stock Option, or more specifically, a Put Option.

A Put Option is a contract relating to a particular stock, that gives you the right to sell that stock at a fixed, pre-determined price within a fixed period of time.

So just like a car insurance policy that expires at the end of a six or twelve month term, a put option would allow you to have insurance on your shares for a certain period of time. This is called a Protective Put and is commonly called Hedging.

Let's say you own XYZ shares that you paid $ 20 for and you would like to insure them for the full value of what you paid, and you wish to have this insurance in place for 6 months.

You would purchase an XYZ $ 20 Put Option with an expiry date 6 months from now. For this you would pay a premium. That premium may be around $ 1.20 but you would then have peace of mind knowing that if the stock market crashed and your shares were suddenly only worth a few dollars then you could exercise your Put Option and sell those shares for the $ 20 you originally paid.

The only loss you would incur then would be the cost of the Put Option, but in many cases the dividends you would receive on your shares throughout this period of time may just be enough to cover the cost of your options, taking nothing out of your own pocket.

Stock Options started out as more of a hedging instrument than a speculative instrument, and these days there are so many different strategies that incorporate the use of Put Options.

Whether it be for insurance purposes or to make money as income in the short term, stock options strategies can be structured for any purpose...yes, you can structure a position to profit even if the stock you are holding falls!