Trading Options and Buying Puts

Chances are that if you have traded in the stock market you have traded long. In other words you buy a stock in anticipation of the stock price going up. And while that strategy works day after day you essentially are only trading one side of the market. As you know not all stocks increase in value day after day. Stocks go up and stocks go down and there are options trading opportunities for both occurrences.

What if you believed that the market for your stock is going to drop in value? What are your options? First of all if you are wrong on the stock, you can sell it to avoid further losses. You may also choose to sell stocks short. The third choice when it comes to trading options is to buy puts. A basic explanation is when you buy puts you anticipate the underlying stock going down in value, and you profit because the puts become more valuable.

Perhaps the most recent example of a sector or a group of stocks showing signs of weakness is the housing stocks a few years ago. As the housing bubble began to expand prior to its burst, stocks were doubling and tripling in price for years. The market and the sector were giving the signs of weakness and the stock prices began to fall. Now, you could have shorted the housing stocks, where you could have bought puts. Remember the underlying stock falls in your puts become more valuable.

One of the single biggest obstacles to buying puts is that most investors have been conditioned to go long on stocks. Shorting stocks and buying puts has a negative connotation that many people choose to disassociate themselves with. The truth is, if more people understood shorting stocks and buying puts, more people would choose a strategy. Technically buying puts is the same as buying calls it just works in reverse.

One investor chooses to buy a put, they believe that the underlying stock will decline in price on or before the expiration date. The more volatile action or the faster and further the stock declines the more valuable the put option is. In markets that have a prolonged decline buying puts could prove to be a very valuable strategy. Understanding the strategy of how to buy puts is essential.

Shorting stocks especially on margin, can get rather risky and expensive if you are not extremely disciplined. In theory your losses on shorting stocks are unlimited, although most investors have very strict rules when they short stocks. On the other hand buying puts is less risky than selling short. We have discussed before the advantage of options in trading options online in that, you cannot lose more than your initial investment. You know exactly how much you can lose in advance. This inherently helps you control the risk.

While few things are guaranteed in the stock market one thing you can be sure of. Stocks will rise in value and stocks will fall in value. For those wishing to trade both sides of the market buying puts can be a lot safer and shorting stocks.