Options Before a Market Correction

By: www.Options-Trading-Education.com

The S&P 500 has been happily going up
with one minor correction for five and a
half years. Stocks are historically high
priced.
By: http://www.options-trading-education.com/24085/options-before-a-market-correction/

As always happens when a rally moves
on to higher and higher prices, talk
centers on when a market correction
will happen, when and just how bad it
will be.

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Our focus is on using options before a
market correction in order to hedge risk
and gain a little profit.

We recently wrote about how to reduce
investment risk with options.

We suggest that if one had a stock that
had gone up substantially it might be a
good idea to purchase put options in
order to protect your gains.

In fact you do not need to own the
stock in question in order to buy puts
on a high flying stock.

Making Money with Put Options

A put option gives the buyer the right to
sell a stock at a price set in the options
contract. This price is called the strike
price.

The buyer pays a premium for this
right. The buyer of an American
option can execute the contract and
sell the stock at any point during the
course of the options contract.

If the contract is a European style
option the trader can only execute the
contract at the end of the contract
period.

In each case the trader can simply
execute the opposite trade and exit the
contract, ideally with a profit.

The buyer is never under any obligation
to do so.

The value of a put option is based on
the strike price of the contract, the
current market price of the stock, time
remaining until expiration and market
expectations.

These last two factors are what are
called the time value of the options
contract. This value shrinks steadily as
the contract period shortens.

The first two factors are clear. If you
purchased a $103 put option on XYZ
Corp. this means that you can execute
the contract and sell the stock for $103 a
share.

If your analysis is correct and the
market corrected the stock may be
selling for $103 a share.

This makes the option worth $20 plus
or minus time value. Buying put
options before a market correction can
be very lucrative. But when do you buy?

Timing an Options Trade

Two factors determine stock prices,
fundamentals and market sentiment.
Today the fundamentals indicate that
perhaps prices are a little too high.

But if the sentiment of the market is
that there are no better places to put
your money than in the rising US stock
market maybe market sentiment wins
and the market keeps going up.

Successful options trading is a
combination of knowing the
fundamentals that eventually
determine stock price and having a
good sense of what is motivating other
traders and investors.

So long as everyone thinks that the
market is going up it will probably go
up until some very dramatic economic
even happens and then it will correct in
a hurry.

Here is where buying options before a
market correction is profitable.

You can buy puts, for example, and
when the stock still goes up you can exit
the contract and buy on with a higher
strike price and continually follow the
price upwards until the market corrects
and then you can collect for your
efforts.

Options Before a Market Correction

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