Foundations of Trading: Options [Part 7]
We are back with our Foundations of Trading Options blog series, and today we will focus on the content Chris presented in class 5. However, before we jump in, please take a look at Chris’ Long Calls Strategy, which he presented in FoT Options Class 3 for when you are bullish on a trade, and his Long Put Strategy, which he presented in Class 4 for when you are bearish on a trade. Just click on the Foundations of Trading blog category on the right-hand side of the page, which will instantly bring up all the blogs from our program for your review.
As a general reminder, a call option gives you the right to buy a stock at a specific price. The monetary value of a call option increases as the value of the underlying stock increases, which means call options are bullish in nature. These options are valuable to short sellers as they function as a type of price insurance. On the flip side, a put option gives you the right to sell a stock at a specific price. The monetary value of a put option increases as the value of the stock decreases, which means put options are bearish in nature. These options are valuable to long buyers as they function as a type of price insurance.
Now that you understand the Long Call and Long Put strategies let’s look at using them as insurance for our stock positions. As I am sure most of you know, when you buy insurance, you pay to protect an asset from a loss in value. A great example of this would be fire insurance on your home. If your house burns down, the insurance company will pay you cash to cover your loss. However, if your house never burns down, you lose the insurance premiums you pay to the insurance company every month, and for most people, the protection on their property is worth the cost.
The good news for traders is that you can buy insurance on your stocks just like on your home. All it takes is an asset that makes money as the stock goes down, such as a Put Option. Remember a Put Option gives you the right to sell 100 shares of the underlying stock at a set price, which is basically an insurance contract. Granted, they are not called that, but like insurance on your home, if the stock never burns down, you end up losing the premium you paid for the coverage of your loss; but if the stock does burn down, your put option will pay out and cover your losses. Just like with insurance, better protection will cost you more upfront as the “cheapest” insurance will only protect you from catastrophic losses in the market.
In Closing
Remember, if you have any questions regarding the contents of this blog or any other blog in this series, please stop by to see our teachers, Josh and Chris, in our Group Coaching sessions which happen every Thursday. That way, you can ask Chris to dive a little deeper into any topic from any of his presentations. For access, please contact Rebekah at info@tradesmartu.com for details on Group Coaching sessions. Thank you for reading, and we look forward to seeing you next week!
