Using "Put Options" to hedge against loss?

Question

I am trying to craft my investment strategy as I am going to begin to invest in stocks very soon. I have been reading alot, and I came across "Put Options", as away of insuring the stocks against heavy loss.
In your experience is using "Put Options" a good idea in general. Or is it sufficient to use only "Stop Loss" instead?

Thanks for the advice.

Answer 1

The main problem with a stop loss is that you can get whip sawed. In fact I have a suspicion that the market makers just love whipping the price of a stock below the stop loss to clean out the weak holders prior to moving the stock up.

Using put options can limit your down side loss if used judiciously. That way you can hold on to your positions without liquidating them perhaps at the wrong time. I have used put options on high beta index funds to protect my portfolio from unexpected market volitility in the hopes that I would loose every penny that they cost. They however do cost you money as does an insurance policy for that matter.

Answer 2

Hedging in this way is too expensive. On one part you are paying the commissions. On the other you are paying for the time value and sometimes if u buy in the money, you are paying for intrinsic value as well. Options do expire!

If you are playing the 'hedging strategy', you need to monitor the market in order to make the maximum out of it.

Instead you could research into good companies with sound fundamental and they fall in to the Margin Of Safety category. It should be a good buy and hold strategy.

The stock price may drop further but you can be very sure the drop will not be far. In fact if you apply the 'buying strategy', you will have a good portfolio down the road.

Answer 3

Don't try to get too fancy with a trading strategy. After 10 years of trading, I'll share what I learned the hard way.

1. Buy a good company with a good product. If you can't explain exactly what the company does, don't buy it.

2. Don't sweat everyday fluctuations. Good companies will go up. (Most of the stocks I tried to time, and buy and sell in a short period, are significantly higher now. I would have done better to buy and hold them)

3. On the opposite end, but companies will keep going down. If your stock is going down, and you realize its a crappy company, get rid of it. Don't hold it and pray it goes back up because you'll get burned more often than not.

4. Sell a stock when the reasons you bought it don't hold true anymore.

I like to buy more well known companies that have been beaten down. To me its the easiest to value. Its worked very well over the last few years.

Answer 4

In general, I agree with the others that it is not a good idea, particularly if by "using" put options you simply mean buying them on a stock you own. There are strategies using puts, such as put ratio backspreads, that I think make sense in some situations if you own the stock. However, options are best used to trade volatility, not direction, of the underlying price. If you want to take the time to understand option trading there is a lot you can do with them, but trading them without learning enough about them will probably cost you money.

Answer 5

If you are a "do-it-yourselfer" I'd steer clear of options strategies. You could get yourself into some hot water. Even many Financial Professionals don't delve into the world of options.

You're fine with a sell stop or sell stop limit (good til cancel).
However, if you're picking well-researched, fundamentally sound, dividend-paying stocks, you should just buy and hold, don't start trading based on market swings, the commissions will eat up all of your profits.

Answer 6

With a volatile stock a stop loss is pretty useless. It needs to be a guaranteed stop loss. If you use a decent dealing platform you can see option prices. I doubt if many people use much hedging in normal share dealing. The portfolio itself should be diversified and therefore sort of hdged anyway.

Answer 7

Typically put options are used for investors/traders who have built up large positions with a longer time horizon in mind, where they don't want to have to keep getting in/out with stock or market fluctuations.

I don't use them myself as protection, but rather as a downward play instead of buying short. As my hedge I buy DOG, DUG, SDS, QID.....ETF's where you make money if the market's going down, and regarding particular stock positions I usually use call options and then use trailing stops to get me out, and if I think it's way over-extended, I'll buy some puts to ride it down.