Stock Investing Can Be Scary Without Using Protective Puts

The investing climate over the past decade has been one of major volatility with the tech stock collapse, the housing bubble bursting and the financial system implosion.  The S & P 500 has been up as much as 28.7% and down as much as 37%.  Oil has been as high as $145 and dropped to under $34 per barrel and is back over $100 again on the unrest in Libya.  It certainly seems that investing in such a climate would be very scary.

It is precisely this type of volatility that led me to use put options to protect my capital on every one of my stock investments.  For those who don't know what a put is, I will explain it.  A put option is an option contract that allows the purchaser to sell a stock at a set price (called the strike price) on or before the expiration date of the contract.  For this contract, the purchaser will pay a premium.  The contract may or may not be used.  Think of it like an insurance policy for a particular stock.

For example, if I own Apple stock because I think the iPad is great and feel that the company will make a lot of money by selling this and other great products, I might want to purchase Apple stock (AAPL).  The stock is trading at $344 per share which would take over $34,000 to buy 100 shares.  That is a substantial investment, and I would hate to think that bad news would come out about earnings or Steve Jobs' health so I want to buy a put option for protection.  I could buy the January 2012 put option with a strike price of $320 for about $33 per share.

That means that no matter what happens between now and January 2012 (almost 11 months), I will be able to sell my AAPL stock for $320 per share.  Even if the stock drops to $250 per share, I can sell for $320.  The premium for that protection does cost me about 10% of the total invest or $3300.  It may seem a steep price but it only seems that way when it is unused.  When used, insurance seems like a bargain.

The whole point of purchasing the put options is to prevent investing catastrophe or at least protect capital when it does occur.  Put options would have been very useful in 2008 when the market was down almost 40% and many individual stocks were down at least that much.  In fact, two of my stocks recently took major hits in price.  One was due to disappointing earnings and the other was because the silver price declined substantially before the recent turmoil in the Middle East.  I was glad I had put options.  It becomes a lot easier to sleep at night and investing in stocks is a lot less scary when using put options to protect investment capital.