Guard Your Portfolio Gains with the Protective Put

An Argentine default, ongoing geopolitical concerns and well, a market that has seen considerable gains without hesitation over the past five years has finally led to a short-term reprieve. Who knows if the decline will continue . . .  but you should be prepared just in case.
Today I’ve decided to give you a glimpse into how I protect profits. Over the past several weeks I have encouraged you to take a look at ways to protect your portfolio. I’ve discussed the benefits of collars and bear call spreads, but there is an even simpler way to protect profits that is geared towards the newbie options investor.
The strategy: protective puts.
Protective puts are reasonably simple, and more importantly, extremely effective in protecting portfolio gains.

The Protective Put

Let’s say you own 100 shares of Microsoft (Nasdaq: MSFT) and it is currently trading $10 above your original purchase price of $32. You want to continue holding the position, yet you are concerned that the bull market is about to burst.
Try a LEAPS protective put.
Long-term Equity AnticiPation Securities (LEAPS) are long-term option contracts that allow investors to establish positions that can be maintained for a period of up to three years.
Example: Microsoft is trading at $42. You purchased 100 shares at $32 over a year ago and wish to hold Microsoft for the long term. You do not want to risk losing the $10 increase in share value, or $1000, and you are perfectly fine paying the cost of insurance if it means that you will be able to keep a decent portion of your current gains.
Outlook: Again, you are bullish on Microsoft over the very long term, but nervous about unseen events over the next three to 18 months.
Strategy: LEAPS Protective Put – Buy 1 MSFT January 2016 40 put for $3.75 per contract or $375 with the stock trading at $42.
The $375 cost of the MSFT LEAPS options insures your stock position to a maximum loss of $575 with unlimited upside potential after the break-even point of MSFT at $45.75, or 8.9% is reached.
The maximum loss is based on the cost of the LEAPS protective put ($500) plus the out-of-the-money amount ($200) at the time of the established position. The most you can lose on MSFT is -13.6%, or $575, no matter how far the stock drops.
The stock could drop back to $40 or below and your max loss would still be ($575).
So, if you are fearful of a sharp push lower in coming months and you want to protect some of your hard-earned long-term profits, think about using a LEAPS protective put. It limits your downside while leaving the upside potential of the stock intact.
If you would like to learn more about how I use options for monthly income, don’t forget to take a look at my most recent webinar.