You are probably aware that options give you many ways to take advantage of any move you are anticipating, in a particular stock or the market as a whole. Whether you trade ETFs or manage an extensive stock portfolio, you can use options to pick up bargains near market bottoms or hedge yourself against downturns if you feel that a near-term retracement is in the cards. Here is one of the many option trading strategies that savvy traders and investment professionals use options to profit when the market begins to show signs of topping.
If you feel very sure that the trend is reversing and a stock’s price is heading lower, you might want to sell, but of course we can never be 100% sure about the future in investing. If you own stocks that have seen outsized gains recently, you might instead choose to hedge against a reversal rather than sell or simply hope for the best.
You could write covered calls against stock that you already own at a strike price that is say 10% to 20% higher than the current price of the stock. In doing this you receive a premium from the option buyer which reduces your cost basis for your shares, which means that you have effectively lowered the price at which you entered your position. If the stock price does take a tumble (a temporary one, you hope) your paper loss will be reduced. The downside of this strategy is that if you are wrong and the price of the stock continues upward your shares are liable to be called away from you at the strike price, so you will not participate in any appreciation beyond the strike price. Still, in some situations it’s a good strategy to employ: if a stock has had a recent spike upward it might be a good time to hedge yourself against a pullback.
There are other strategies to use for protection against a pullback, such as buying protective puts, and there are plenty of excellent places on the Internet to get stock options explained to you. The bottom line is that options give you a way to protect yourself from the pullback without actually having to sell your shares outright.