One woman owns a lovely stock for a company that she expects to stay at $25. But, there is a chance the stock could plummet in the near future. To cover herself from this scenario, she purchases a put option to protect the sale and secure some additional space. The stock invariably plummets to $5 a share, a drastic drop with catastrophic results. But, the investor has protected her sale with a put option registered at $20, so she is able to sell at the $20 price.
Put Options As a Safety Net
This is the essential idea of put option stock investing. Put options can be seen as a safety net of sorts and many investors will opt to add a put option to their portfolio to protect from a disaster.
The above is an example with the broadest terms and numbers, but it illustrates the basic idea of a put option. It also misses a lot of the realities of put optioning, such as the limitations and the time frames. A put option at $20, in the above example, may cost nearly as much as that.
Restrictions of Puts
Furthermore, it may not work for a long period of time, as there are expirations involved with optioning. It may also not work if the drop falls below a certain threshold. All of these things limit put options in their validity and viability. Investors need to apply them sparingly and with some practice before going all in.
Many investors use put options to avoid needless short sales. They want to protect their assets on the way down. It is a perfectly reasonable strategy, but many investors forgo it because it adds an extra variable to consider. It can lead down unnecessary roads. It is just another thing to keep in mind and it could encourage weird responses.
More options, in some ways, open up more pitfalls. Some investors stick to the basics of what they know. Purists like to own, strictly, and invest with fewer cushions. Looking for more? Day traders can see Markus Heitkoetter on LinkedIn to explore his long history in the field.