Insurance is an important part of the world today. I buy auto insurance for my car in case there is an accident. I have life insurance to protect my family financially. My home is insured against fire or weather-related damage. I have health insurance to cover medical expenses.
Yet, given all the insurance that we buy from one year to the next, it's surprising to me how many people never consider buying insurance for their stock portfolios. There are tools available to do so, and one of them is called the put option.
Put options are not exactly like insurance, and some important differences will be addressed in this chapter. Nevertheless, a put option is a tool that can be used to hedge (or protect) an individual stock position from a price drop for a limited period of time. Index put options are often used to hedge entire stock portfolios.
Put options are also used in other ways. For example, an investor can sell puts as a way to collect a premium if she is willing to buy the shares (have the shares put to her) at the strike price of the option at a later date. Selling puts as part of a cash-secured put strategy is covered in Chapter 12.
Meanwhile, a long put is sometimes used when an investor is expecting shares of a stock to decline in price and wants to participate in the move lower or as a temporary hedging strategy to help protect a long position without selling it out. Specific examples of long puts on single stocks and indexes are ...