Typical day traders and swing traders look for stocks with quick,short term movements, and are not in the business of holding positions overnight let alone a week or two. So the use of options has not usually been a component of their trading strategies.

Now however, some new opportunities for profit are available since many day trading firms are allowing their traders to trade options. Unfortunately, many option strategies do not apply to the quick in and out nature of day trading. Neither day traders nor swing traders are typically in a single stock long enough for the strategy of selling options for premium collection to be viable.

Since these traders often look for break-outs, and sometimes go bottom fishing to find opportunities for profit, a premium paying option might work well for them. Why? Because the trader would be buying protection from catastrophic losses. Bottom fishing and breakouts are associated with volatility, which means uncertainty and risk. However, there is a strategy that will provide the necessary protection for these traders to carry positions through overnight risk, while remaining fully protected. This would still allow also them to take advantage of the large potential upswing that was the original goal of identifying the bottom and the break-out. This strategy is called the protective put.

THE PROTECTIVE PUT

The Protective Put Strategy involves the purchase of put options in combination with the purchase of stock and works well in situations where a stock is prone to rapid, volatile movements.

A put option gives an owner the right, but not the obligation, to sell a certain stock, at a certain price, by a specified date. For this right, the owner pays a premium. The buyer, who receives the premium, is obligated to take delivery of the stock should the owner wish to sell at the strike price by the specified date. A strategically used put option offers protection against substantial loss.

The protective put strategy is a strategy that is ideal for a trader who wants full hedging coverage. This strategy is very effective in stocks that normally trade under high volatility, or in stocks that normally do not trade under such high volatility but may be involved in an event driven, highly volatile situation.

When an investor purchases a stock, they can buy the put (protective put) to provide a proper hedge. The construction of this position is actually quite simple. You buy the stock and you buy the put in a one to one ratio meaning one put for every one hundred shares. Remember, one option contract is worth 100 shares. So, if you buy 400 shares of IBM then you need to purchase exactly four puts.

From a premium standpoint, you must keep in mind that by purchasing an option, you are paying out money as opposed to collecting money. This means that your position must "outperform" the amount of money that you paid for the put.