How Options Can Help Your Portfolio

Kiplinger's Personal Finance|July 2020

How Options Can Help Your Portfolio
Although the terminology may take some getting used to, options are just another investing tool for generating income or protecting you from a market sell-off.
MICHAEL SHULMAN

FOR SOME PEOPLE, OPTIONS TRADING conjures either fantasies of instant riches or nightmares of losing everything. But those are the visions of market-timing speculators, not longterm investors. For most investors with a long-term view, trading options is a way to protect individual stocks or an entire portfolio from a downturn. Moreover, used conservatively, options can generate cash in amounts that far exceed the average dividend. This guide is meant to walk you through some of the basics.

First, the nuts and bolts: An option is a contract that gives its holder the right either to buy shares at a fixed price (a call option) or to sell shares at a fixed price (a put option). The price at which you can either buy or sell the underlying shares is the strike price, and the price of the contract itself is the premium. You’ll pay the premium if you purchase an option, or you’ll pocket the premium if you sell a contract to someone else. An option contract represents 100 shares of the underlying stock, and the contract expires on a fixed date; the holder may exercise an option on or before that date. Listed premiums are multiplied by 100. For example, if the premium is listed at 50 cents, it means the cost of buying that contract is $50.

The first hurdle newbies face is understanding the options chain, a matrix of information about available contracts that you can find on most brokers’ sites or trading platforms. The vast majority of brokers make it simple to read the matrix and do not confuse you with the actual symbols used by the exchanges. Most large-company stocks, such as Apple (symbol AAPL), Disney (DIS), Gilead Sciences (GILD) or JPMorgan (JPM), are good candidates for options trading; they’re said to have liquid option chains. Many smaller companies, such as Square (SQ), have option chains that are also easy to trade.

While many thousands of stocks have options with one expiration date per month—the third Friday—roughly 500 stocks have options that expire every Friday.

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July 2020