How to Use Stock Options to Insure Your Holdings Against Short-Term Pullbacks

Stock options are among the most versatile tools available to investors. They can be used as a low-cost way to speculate on expected price movements, generate added income on stock holdings, and to lock in gains on profitable positions or hedge against market reversals. The latter strategy typically involves buying at-the-money put options on your long stock positions. This creates a situation akin to an "insurance policy" in that your profit on the put options will offset most or all of the loss on your stock should prices turn lower during the life of the option.