Trading uncovered: How to use put options in your portfolio

Julie Brownlee, Fsp Invest, 17 Feb. 2015

Tags: put option, put options, what is a put option, trading put options, hedging your portfolio, trading, trading options

Options are by far the most popular trading tool in the US. And they’re available to trade in South Africa.

Options give you the right, but not the obligation, to buy a financial asset, such as shares, for an agreed price on or before a certain date.

There are two main types of options available to trade: Put options and call options.

Let’s take a closer look at how put options work…

The basics of put options

If you want to have the option to buy or sell a share, for example, you have to pay a premium (a fee) to the seller of the option (otherwise known as the option writer).

A put option gives you the right to sell a share.

If you think the price of a share is going to fall, you could buy a put option to try to profit from the fall in the share price.

How to hedge your portfolio using put options

Many investors use put options as a way to hedge their portfolio against a drop in the market. This is a strategy used by many fund managers.

By buying put options on a stock market index, if the stock market falls, the profits on the options will offset the losses on the shares in their portfolio.

In South Africa, options are based on the underlying single stock futures contract, which is based on the underlying share. This means that each options contract is equal to 100 underlying shares.

Put options in action

Let’s take a look at an example of trading put options…

Company ABC is trading at 100c a share. A put option gives you the right to sell at 90c. The premium is 5c.

The cost of the option is R5 (5c x 100). If the share falls to 70c, you could make a profit of R15 ((90c-70c-5c) x 100).

If the shares go up in value, you’d let the option expire. You’d lose your premium of R5.

So there you have it, how to use put options in your portfolio.

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