There is a knack to buying puts. The key is to buy the option before the stock falls. Easier said than done. Surely no one knows with certainty whether a stock will fall or not. (If they did, the wouldn’t need to hedge with options!) So how does one know when to buy puts?
There are two factors.
1) Your level of concern. Research and good old fashion gut feel play a key role here.
2) Value. This is the trickier endeavor. Once you decide that you have a stock that is causing enough concern to consider buying puts for protection, you must ask, “Is it worth it?”
Yesterday Research In Motion (RIMM) closed at $52.97. If you wanted to buy a 44-day, 50-strike put you could have lifted the offer of 5.35. That’s more than 10 percent of the value of the stock. And RIMM would have to be more than 5 percent lower at expiration for the put to kick in. Unless you are really concerned about a huge drop (more than another 15 percent from the current price) this insurance is hardly worth it.
Protective puts need to be chosen selectively. Pick your spots. Puts tend to be especially expensive in volatile markets. Remember, once the move has happened, it’s over. There’s nothing you can do about it. Buying overpriced puts after the fact is often a fool’s errand.
Dan
Market Taker Mentoring LLC
