Many people think of options trading as very risky and suitable only for the "high rollers". In this article we will demonstrate one of the ways options can be used in conservative financial portfolios.

The basic definition of a put option is that it gives the owner the right, but not the obligation, to sell 100 shares of the underlying stock at the strike price anytime before expiration. If I buy 100 shares of Apple Computer (AAPL) at $136.50 or $13,650 and buy one contract of the Oct $135 put for $10.50 or $1050, I have a total investment of $14,700. This position is called a married put; we are long the stock and long the put (long means we own the stock or option; short means we have sold it and have an obligation to buy it back). If AAPL goes up in price, my stock will appreciate but my put will expire worthless. On the other hand, if AAPL decreases in price, my put will increase in value and make up for a portion of my loss on the stock price, i.e., the put acts as insurance for my stock.

A married put is analogous to your homeowners insurance; you paid $1000 at the beginning of the year for insurance to cover your home in case of damage from fire, storms and so on. At the end of the year, your home was not damaged and you lost the $1000 you paid for insurance. On the other hand, if a storm had caused $20,000 of damage to your home, the insurance company would have paid to have it repaired and you would be glad you had paid that $1000 bill for the insurance.

The married put is similar; if the stock price does nothing, our put expires worthless and we did not need our insurance. In this example with Apple, the insurance cost us $1050 (the cost of the put option). But if you are watching the evening news and see Steve Jobs being escorted from his office by FBI agents in handcuffs, you begin to worry. The next morning, APPL opens at $92, but we look at our account online and see a balance of $13,700 - we are only down $1000 or 7% when our stock has collapsed by over 30%; those may not be the exact prices, but you get the idea. Some of our stock price loss has been covered by the put.