Buying Index Puts Summary

For those who are very bearish on a particular index over the near- or long-term, and who require a known, limited upside risk, buying a put might be an appropriate strategy to use. Purchasing an index put option requires a smaller initial cash investment than the margin requirement for a short sale of multiple shares of component stocks. In addition, there are no margin calls, nor does a put holder pay any dividends. This reduces the capital at risk and offers the potential of leveraged profits if a bearish outlook proves correct. As the underlying index level continues to decrease, the long put’s profit potential is limited only by the index declining to no less than zero, and large returns on investment can be seen. On the upside, the investor with short stock positions is exposed to a potentially unlimited dollar loss from an increase in share value, while the put buyer’s maximum loss is known in advance and is limited entirely to the option’s purchase price.

Today's investor has a choice of shorter-term expiration months afforded by regular index option contracts, longer-term expirations available with LEAPS®, as well as multiple strike prices. So no matter an investor’s anticipated target price for an underlying index after a bearish move, or the time frame over which this move might occur, there is most likely a call contract that fits both his outlook and tolerance for risk.


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