Protecting yourself from the downside

                Protecting your money from the downside is very important.  This is especially true when the markets are volatile and you do not know what they are going to do. 

                The reason for spending a lot of energy protecting your capitol is important is simple.   As a trader you need money to make money.  Your investment is very important.   If you lose all of your money during a rough time you will have no money left to make a profit when the markets turn favorable.

                Now that we have talked about why you should protect yourself from losses when the markets start acting up let us talk about how you can do that.  The most widely used strategy for big corporations during this time is called a protective put strategy.

                This strategy protects us from downward movements while at the same time allows us to keep any profits that we might get in the stock.  The strategy involves buying a put on a stock that you already own.

                A put gives the buyer the right to sell a stock at a given strike price on or before a given date.  In other words if you own a stock that is trading at $96 and want to protect from the downside you can buy the $95 put for say $4.

                Now you have the right to be able to sell that stock at $95 if you need to.  So even if the stock crashes to $30 you can still sell it at $95.  Many traders see protective puts as an insurance policy.  You pay money to the insurance company and if your house burns down you can get compensation for it.

                That is similar to how this works.  Of course all puts eventually expire and should be used only when you are worried about the market.  It would not make sense to pay $4 every month or two on a $96 stock to protect it from the downside.