Tuesday, November 3, 2009: Issue #1129

Here's the situation… We have an uncertain, volatile stock market that can't figure out its next move.

Thanks to the rally for much of this year, many investors have recovered a good chunk of what they lost in 2008. Some are even sitting on some big profits in a few positions.

What do you do now?

Some investors will lock in their gains and retreat to the sidelines. Others will stay invested and take their chances.

Whose approach is right?

Neither. There's a better way to protect your profits without selling anything, and you can do it by executing a married put option strategy. Here's how it works…

The Art of Put Options

Put options primarily used to accomplish two things…

• Selling stocks: When you buy a put option, you have the right, but not the obligation, to sell a stock at a certain price (strike price).
• Buying stocks: When you sell a put option, you're obligated to buy the underlying stock at the designated strike price, as long as the shares are trading below that strike price.

Today, we're going to focus on the buy side.

Let's say we bought Intel (Nasdaq: INTC) for $13 back in March. Today, we're sitting on a $6 profit.

In a market like this, that gain could evaporate in a hurry. Alternatively, it might not if the market heads higher. So we're stuck, right?

Well, no.

Most ordinary investors would employ a simple 20% trailing-stop from current levels, meaning they'd sell the position if the stock falls by $3.80. An important admirable strategy in order to protect profits, or limit losses – and one we frequently preach here.

But what if you could actually protect your downside for less money for a pre-determined period of time?

How to "Marry" Your Stock Position With a Downside Hedge

If you buy a put option, you're hedging against downside on the underlying shares. So if the stock declines, the option will increase in value. On the other hand, the option will decline in value if the stock rises.

But at no time will you risk losing more that what you paid for the option.

So let's say we expect the market to be rocky for the next six months.