Buying a put option gives you the right to sell a stock at a set price (strike price) before a certain date.
If the stock drops, your put increases in value — like insurance for your portfolio.
1. Why Buy Puts?
- Protect your stock from a sharp drop.
- Speculate on a falling stock without shorting.
- Limit your risk — maximum loss is the premium you paid for the put.
Think of it like paying for fire insurance:
- If the fire (drop) happens → big payoff.
- If it doesn’t → you just lose the insurance cost (premium).
2. Real Example: Hedging Tesla (TSLA)
Suppose you own 100 shares of TSLA at $250.
You get a strong sell signal — maybe technical (moving average crossover, RSI), or fundamental (earnings warning).
You want to protect yourself without outright selling.
You buy:
- 1 Put Option
- Strike price: $240
- Expiration: 1 month out
- Cost (Premium): $6 per share = $600 total
3. Outcomes:
| Scenario | What Happens |
|---|---|
| TSLA drops to $220 | The put is worth $20 per share → you gain $2,000. |
| TSLA stays at $250 or rises | Put expires worthless → you lose the $600 premium. |
Notice:
- If TSLA tanks, the put offsets your stock loss.
- If TSLA rises, you still own the stock — but you paid $600 for peace of mind.
4. Profit/Loss Visual
At expiration:
- Your put’s breakeven = Strike Price – Premium Paid → $234 ($240 – $6)
- Below $234 = you profit on the put.
- Above $234 = you lose less (or all) of the premium.
5. Smart Hedging Tips
- Short-Term: Use puts 1–2 months out — hedging is for short, sharp moves, not years.
- Out-of-the-Money (OTM): Buy puts slightly below current price (e.g., 5–10%) to keep costs reasonable.
- Sizing: Hedge only what you need (e.g., 1 put = 100 shares).
6. When to Consider Buying Puts
- Technical breakdowns (stock drops below key moving averages)
- Earnings risks (bad earnings expected)
- Macro signals (Fed tightening, recession warnings)
- Overbought conditions (extreme RSI, sentiment)
7. Quick Table — Hedging Costs and Expectations
| Stock Price | Strike | Premium | What You’re Paying For |
|---|---|---|---|
| $250 | $240 | $6 | Moderate protection, cheap |
| $250 | $250 | $9 | Full protection (at-the-money) |
| $250 | $260 | $14 | Deep protection, very expensive |
Tradeoff:
- Cheaper put = less immediate protection.
- More expensive put = better protection, but higher cost.
8. Advanced Move: Put Spreads
If buying puts feels too expensive, you can lower the cost by creating a put spread:
- Buy a put at $240.
- Sell a put at $220.
- You pay less upfront, but your maximum hedge is capped.
Good for precise, short-term hedges.
Final Word:
Buying puts is like buying a parachute — expensive if you don’t need it, priceless if you do.