Tuesday, July 7th, 2020

How Can Options Protect You From a Market Meltdown?

February 24, 2020 by Jim Walker  
Filed under Options Trading Education

 

The long bull market in stocks has been sustained by continuing profits, especially from the tech giants like Apple. But, even Apple is looking at decreased earnings due to the expanding reach of the Chinese coronavirus. Are you tempted to get out of your stock holdings? What is the effects of the virus on the economy and stocks are short-lived? Then you will have missed out on continued profits. But, if you don’t do anything, you stand the risk of losing a substantial portion of your portfolio! How can options protect you from a market meltdown?

Buying Puts to Protect Your Stock Market Gains

A put is an options contract that gives the buyer the option to sell the underlying equity which he will do if the equity price moves in the direction anticipated. A put contract confers an obligation on the seller (writer) of the put option to buy the underlying equity if the buyer executes the contract.

Investors who fear a market meltdown but don’t want to permanently leave an attractive stock position can buy puts on the stock they want to keep and protect from devastating losses if the market collapses.

The worst loss that you can experience in this case is the cost or the options contract. Those who have ridden the bear market up from the depths of the financial crisis will have accumulated substantial gains. They don’t want to exit their positions and pay long term (or short term) capital gains taxes only to have to reinvest at a premium if the market or their specific stock does not collapse.

Because you can buy put contract going out as far as two and a half years, you can usually protect yourself from the sort of short and medium term market events that would hurt your investments. Knowing when to buy puts is important.

Buying Calls to Take Advantage of Stock Market Gains

If the stock market takes a beating due to the effects of the trade war, the election of Bernie Sanders, or the spreading coronavirus, when should you start to buy again? A good approach using the options market is to buy calls on stocks you believe will recover over time. A call option gives you the ability to buy a stock in the future at a price set by today’s option contract. This price will hold for the duration of the contract and will not go up even if the stock price skyrockets.

You can buy calls on depressed stocks and either sell the contract for a profit when the stock goes up or buy the now-recovered stock at a bargain and hold it for the long term.

The worst that you will do with this approach is to lose the price of the call contract if the stock does not go up. Finding attractive call contracts in a down market can be very profitable.

In short, by either buying puts or calls, you can either protect yourself from a market meltdown or profit when stocks recover.

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