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Use Puts to Preserve Stock Gains
A useful strategy for investors is to use puts to preserve stock gains. This approach can be used when the stock price is rising rapidly and when the price is volatile as well. How do options work in this regard? First, let us look at options contracts.
Puts in Options Trading
What are calls and puts in options trading? Calls and puts are contracts in which the buyer purchases the right to buy or sell a stock. A call gives the individual the right to buy but in this case we are interested in puts. A put is an options contract in which the buyer pays for the right to sell a stock at a predetermined price no matter how low the stock price may fall. The buyer is under no obligation to execute the contract so he will do so only if there is fall in price. An options trader who expects the price of a stock to fall can purchase a put on the stock. If the stock price falls as expected he can buy the stock at the lower price, execute the contract and be paid at the strike price, and pocket the difference. But if one already owns the stock a put can be seen as a form of insurance as well. Stock investors can use puts to preserve stock gains.
Preserving Stocks Gains with Puts
The stock of XYX Corp. has been rising for half a year. The company has developed a new line of hot selling products and controls its market niche. As the stock has become more and more popular many new investors are entering the stock market for the first time in order to become owners of XYZ stock. As is often the case with newcomers to the market they are paying a premium for the stock and helping drive the price above what fundamentals will support. An early investor in XYZ Corp. is obviously very happy. He or she is also worried that other smart investors will start to take a little stock off of the table or that XYZ Corp. earnings will start to flatten out as competitors chip away at the market for XYZ products. If the stock holder in XYZ believes that the stock has simply run its course he will sell and take his profit. But, in this case, he believes that new products will drive XYZ to greater heights. And, in the meantime, the stock might still be subject to a huge correction in which he could lose half of his gains in XYZ. What is options trading with puts in this case? It is an insurance policy. The investor will not sell his stock but he use puts to preserve stock gains. If the stock falls in the near future he can do one of two things. He can exercise his put option and sell the stock, wait for it to bottom out, and buy again. Or he use puts to preserve stock gains in a simpler manner. He will can his options contract and continue to hold the stock. The end result will be the same if he chooses to use puts to preserve stock gains in XYZ.