In the second of a 4-part series, Kim Parlee speaks with Bryan Rogers, Client Education Instructor with TD Direct Investing, about the benefits and risks of buying a put option. TD Direct Investing is holding an Options Month in June. Register at www.td.com/OptionsEducationMonth.
Speaker 2 [00:00:08] Well, I want to expand today, Kim, on what options can be used for. We're all familiar with, you can, in your portfolios, you can buy stocks, you can buy ETFs and mutual funds, but many don't know why or how would you use options. So, you know, there is risk of investing with options and that can be high. But that's ranging from, you know, losing your initial investment, to unlimited risk in some scenarios. So it's important to understand that risk-reward relationship of option strategies. But once you recognize that, you can use options to help you create opportunities for profit, you can generate income and you can even protect your existing holdings.
Speaker 1 [00:00:48] All right. Well, let's start with that then. How do you do that?
Speaker 2 [00:00:52] Well, potential opportunities for profit, so there are three different areas I'm going to look at. For the profit, you can you can buy calls. So that's the scenario we looked at last week, where you're hoping that the stock is going to increase significantly and you're going to lock in that price using that small fee over a small period of time you can buy that call option. Income, we're going to look at that next week. There's a concept called a covered call, and that's where you're selling an option against a stock you already own. So we'll look at that in a lot more detail next week. And then seeking protection on your unrealized profits, for example, when the markets are really high, you can do this with a Put option. And that's what I really want to focus on today.
Speaker 1 [00:01:32] All right. Well, let's let's talk about that Put option. And I think a lot of people have been watching these markets and the volatility are going to be leaning in and listening very carefully, Brian. So what do you do?
Speaker 2 [00:01:43] Absolutely, so a Put can be used to provide some level of protection? So think of it like your home insurance, Kim. All of us know home insurance so I think that kind of makes it more familiar. You buy a policy, you're paying a premium, and we even use the same terminology with options. You're paying a smaller fee to be able to protect yourself from a major financial loss. If there's a fire or a tornado or something like that, the Put concept is the same thing. You're going to pay a smaller fee to be able to protect the stock. So you're going to be able to sell the stock at a higher price when that stock drops. So mainly your Put aims to protect your portfolio from a potentially significant loss.
Speaker 1 [00:02:24] Let's, I think all this stuff really kind of comes to life and we can use real numbers and real examples. So let's do that with the Put.
Speaker 2 [00:02:33] Yes, yes, so a Put, you know, if you're looking at a while ago, I looked at some past examples, when you think back to before the pandemic, right around, that maybe January, February time frame of 2020, almost all stocks seem to be pretty high, but in particular, a lot of bank stocks were rising pretty high. So, as an example, I took a look at Bank of America. So let's say if you owned 100 shares of Bank of America stock, which is similar to BAC and it was mid-February of 2020 and it was trading, at that time, it was trading at $35 a share. So if you had a nice gain in the stock and were thinking, I want to keep this, I don't know if I want to sell them, but I'm a little bit nervous of the market having a pullback or a major drop. So that's where you can look at a Put option to help protect that position at $35. So the cost at the time of a $35 Put option, expiring at 45 days, was about $1.50. So it's not, you're not only paying just the $1.50, but if would be nice if you had just that $1.50 to pay, but it's in multiples of 100. So to protect 100 shares it's still only $150 to protect that lot of 100 shares. So, then one Put gives you the option to sell 100 shares at $35. So the BAC, if it drops below a 35. And here's what happened, Kim. I don't know if you remember this, but BAC dropped down to $19. So it was a pretty significant drop, right? And I think everybody was familiar at that time. But you know, in a situation where, if you were nervous, you can now use the option to sell the shares at $35. So you would've taken $3,500 minus your $150 cost, that would be about $3,350. So, depending on whatever you paid for it, your gain would be what it is. But it's, you know, versus losing $1600 on that $16 drop of unrealized gain if you were to have to sell it at that lower price. Which I think a lot of people did when they got nervous and unfortunately we were forced to make those sells, right. The beautiful thing about options too is you don't necessarily have to sell the stock. Like you mentioned last week, the options give you that right to exercise. So if it did go way down, like our scenario, we could actually even sell the option too for pretty much a similar offsetting amount, keep the shares, and hold on to them waiting for a recovery.
Speaker 1 [00:04:52] That is a nice scenario. When it happens that way, you know, nobody wants to see their shares go down. But when you actually have the insurance in place and it works, you know, it feels good. Let me ask you about the other side, though. So let's say that you hold the shares and the shares went up from where they, even above that, the Put price, not the price of Put, but the strike price. So what does that mean? What do you lose in that situation?
Speaker 2 [00:05:21] Yeah, that's an important thing to highlight as well because, you know, with an option, you're going to lose that initial outlay, just like with our call option example last week, you would lose the $150 in this case. So that's the entire premium. Doesn't seem like a lot, but it is a lot in terms of it's 100% of that Put that you're purchasing, right? So you're, in this case, trying to protect yourself. But think of it like insurance again. You know, when you pay your premium every year for your home insurance. If you didn't make a claim and your home didn't burn down or nothing bad happened, you still have to pay that premium, right? And you lose that and then you have to do it again next year. So the risk to avoid the loss of that $1600 with our example was $150. If it didn't drop, you still get to keep your shares. The shares could continue to go up, but you do lose $150, after that 45 days it expires, and they call it expiring worthless.
Speaker 1 [00:06:10] Still I guess that's a whole lot better than having to pay that premium and not having the house burn down at the same time. All right, we're going to leave it there for the Puts right now. But Brian, next week I think you're going to be talking about covered calls on stocks already owned. But I also want to mention that this is options month at TD Direct Investing, all for the month of June. So can you tell us a bit more about what it's about?
Speaker 2 [00:06:32] Yeah, absolutely, we're really super excited about this, especially for the option nerds like me. We're excited to see that the entire month we do classes all the time that are on all kinds of topics related to investing. But this is going to be all about options. We're going to have five different industry guests, Phil Davis, Stalwart on BNN will be there. And, you know, if you want to register and you know a little bit about options or even if you know nothing, you'll find something you're looking for and you can register at www.td.com/OptionsEducationMonth.
Speaker 1 [00:07:08] All right. Thanks so much.
Speaker 2 [00:07:11] Thank you.