In the second of our two-part series, Greg Bonnell speaks with Bryan Rogers, Senior Client Education Instructor with TD Direct Investing, about the benefits and risks of buying a put option. TD Direct Investing is holding an Options Education Month in May. Register at www.td.com/oem
* Bryan, last week, you showed us a simple example of a call option. What are we looking at this week?
* Well, I wanted to expand on some additional ways that options can be used. It's common to own stocks, ETFs, mutual funds in your portfolio. But many don't know how or why you would use options.
So there are a number of different strategies, as I mentioned. There's up, down, and sideways movements you can look at. So adding options can do a number of things. You can create options to-- opportunities to profit. You can generate income. But you can also protect a position in your portfolio. And that's the one I want to talk about today because I think it's relative to today's market. If you're a little bit worried about what's happening with a position-- or sometimes even you can protect your portfolio in some ways, as well-- you can actually-- if there's going to be anticipation that the market is moving downward, you can use a certain type of option to protect that position.
* Now you know we're curious, how do you do that?
* Well, I knew you'd ask, Greg. So as I mentioned, there is those opportunity to profit, like we talked about last week, with a call option. What we're looking at today is a put option. So protecting an unrealized profit, maybe if you've already bought a stock-- let's say if you bought a stock at $20 and now it's at $40 and you're hoping that if it does dip down, you want to still keep some of that profit-- there is a way to use a put option that's going to give you the guarantee now to lock in a sell price. So you're able to sell that stock at a certain strike price. I know we talked about last week we have that ability to lock in the buy price.
A put option-- so you have the name call. Think of that as call up. You're hoping that the stock's going to go way up. Put down-- if you think that your-- possibly your own position is going to drop significantly and you want to lock in that price to be able to sell it at a certain price, you can use a purchase of a put option. And it's almost like buying insurance, in a way. You're going to be basically paying a premium to the person that's selling that option. And they're like the insurance company. They're going to guarantee that they'll allow you to sell that stock at the higher strike price.
* That's funny, Bryan. When I took the securities course, that was actually my rhyming scheme, call up or put down. So explain maybe a bit further what you're doing when you buy that put option.
* Well, just going back to that insurance example, again, if you think of insurance, when you pay, say, for your house, if you pay $500 in premium-- maybe it's more expensive these days-- could be $2,000, $3,000, depending on your home-- it's a lot less than paying $600,000 to replace your home if you have a fire or some type of a catastrophe or something like that. You're paying this smaller amount, the smaller premium or fee, which is the same thing you would do with an option. You can pay that smaller fee to lock into that price. And if the stock drops way below that locked in price you have, you can exercise your right to sell that stock at that locked in price you had.
So puts can protect your existing portfolio from significant losses. And you can also even use it-- you can use index options in some cases to protect maybe the whole portfolio if you think there's going to be just an overall drop in the market as well.
* We've got a pretty good understanding now of put options. Let's get some real numbers, a real example behind it.
* So like we did last week, I want to jump into WebBroker because it gives you a sense of what the numbers are. You can look at the numbers on a particular stock. So if you happen to own Bank of America and you bought it quite a while ago-- maybe if you bought it at $20 number, it's at around $29.71. And maybe if you're a little bit worried that it was going to drop, you could actually look at an option chain. So you click on this option chain here.
And we're going to be on the right side today. We're going to be looking on the puts on the right side. And then we want to select a time frame, too. Let's say if you're a little bit worried in the next couple of months, you can look at, say, January 16. As soon as I click on that, it's going to tell me the number of days-- so roughly around 53 days.
You can use this dropdown to go a little bit further. But what we're going to do is we're going to scroll down to this green line. And we're looking at this put-- or Bid and Ask column-- is what we want to look at. These are the prices for the options.
So it's not too bad where, if we're close to this green line-- if we go at $29, we could go to $30, we can see these prices in these columns right here. $1.25, which would be $125, would be that cost, that little premium, you'd pay to protect yourself to sell-- to be able to guarantee that you can sell the stock at $30 within that 53 days if it does drop significantly. So if you looked at one even a little bit lower, like at $29, you can now lock in that $29 sale price for a bit cheaper. It's going to cost you $0.83, which is $83, or $54 if we look at that $0.54, and so on.
So the premiums are a little bit lower because Bank of America is not an extremely volatile stock. But if you did anticipate a potential drop in the stock in the next couple of months, this is a way to protect it, where you'd now have in your hands the ability to force someone else to buy your shares at that higher price if it does happen to drop in the market.
* So now the understanding with our audience is that perhaps some protection here from downside-- is this something you'd want to do with every stock in your portfolio?
* I would say it's not very practical from a cost perspective, Greg. You could do it. But just as you notice there with that Bank of America, it'd be costing you roughly around about $80-some on the one that's a little bit below the current price. We went around to $55 for one that's a little bit lower. So you'd want to gauge is this going to be cost-effective for yourself, depending on how many positions you have or stocks you have in your portfolio, or you could do, as well-- is if your portfolio represented a certain index, like the TSX or the S&P 500, something like that, you could [AUDIO OUT] an index, ETF as an example. And you could buy a put option on that. And that may represent just your whole portfolio. If it does drop significantly, you might be able to make enough money to sell that put if things do drop to offset some of the losses in your account.
* Before I let you go, I want to remind everyone that TD Direct Investing is holding an Options Month in May, where the audience can join in. And tell us briefly about Options Month.
* We're all really super excited about this, Greg, especially as instructors as well. We have what are called master classes. So if you're brand new to options and you want to learn what they are and get some more experience with this, or even if you have some experience with options, we're going to go into some more higher level content. But it's an entire month where we're going to have webinars with live industry experts. We're going to have an instructor, such as myself, teaching classes where you can ask questions. And we'll have all kinds of different videos and everything all related to options. You can register at www.td.com/oem and see if you can find something you're really looking for.
* That was Bryan Rogers, senior client education instructor with TD Direct Investing. I want to emphasize that while the goal of today's segment is to educate you on options, you need to decide for yourself whether trading options is right for you in terms of risk profile, amount of time you have, your resources, just to name a few considerations. Any information we provide does not constitute financial, legal, tax, or investment advice.