We pay a monthly premium to insure many important things in our life. Day to day, we take comfort in the fact that if something should happen; things that are important to us are protected from unforeseen misfortune. Why then do so many Canadians fail to insure their investment portfolios?
A PUT option is a contract that gives the owner the right to sell a specified number of underlying shares at a specific price for a specific period of time. Each PUT contract controls 100 underlying shares.
The simplest approach is to use a strategy called a married PUT. A married put refers to the purchase of shares in a specific company in combination with a PUT option that guarantees the sale price, regardless or how far the stock price drops if you are wrong. Much like a standard insurance policy, we pay a small premium for such peace of mind. Let’s say we buy 100 shares of ABC Company at $25.00/shares for a total of $2500.00. If we wanted to protect our 100 shares, we can purchase a policy (PUT option contract) expiring in two months that will give us the right to sell the stock at $25. The premium we pay for this insurance is $1.20/share or $120. With the purchase of this PUT we not have the right to sell our shares at $25 regardless of how far the market value drops. Essentially, we are paying an insurance premium to completely eliminate the risk of loss, while enjoying 100% of the upside potential for 2 months.
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