Options Trading: Hedging Against a Loss

One way that many investors use options trading is as a hedge against possible losses in stock price that might result from market fluctuations.

When you trade in options, you have three choices as to how to make a profit. You can buy or sell the stocks (pick an option that is most likely going to be exercised), trade the option itself, or use the option as a hedge. In this article, we will briefly examine how to use options trading as a hedge against loss.

Options trading can be considered much the same as an insurance policy. If you feel that a stock price is going to drop but are hesitant to sell in the current market, then you may opt to buy a put option when the price falls just below the current market value.

In options trading, a put option is one that gives the owner the opportunity to sell their stock shares at the agreed strike price. In this way, if the stock’s value decreases, the investor can exercise this option and sell his or her shares at a profit – the higher price. Another choice is to sell the put at a profit, which reduces the cost of acquiring the stock in the market.

Of course, if the price of the stock does not decrease, then the investor loses what he paid for the price of the put. There is still an option to sell the put option before the contract’s expiration date and recoup most of this cost, if desired. Or you could also put in a stop-loss order to your broker in order to prevent a loss. This is just another method of loss insurance.

While using options trading as a way to hedge against losses can be a great strategy for the experienced trader, it may not be the best choice for a novice investor. Take some time to get used to reading market conditions and improving your accuracy regarding rising and falling prices before relying on options trading as a portfolio insurance policy.

Learning to trade options is not difficult. I certainly had no prior knowledge of trading the markets until I stumble on Planet Wealth's ebooks, which have been a great resource for my learning. Make no mistake, options can be tricky to trade, but when armed with the knowledge, it can be one of the most powerful instruments you can use to make money in the markets without having to monitor it 24 by 7.

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