Booyah Breakdown: Know Your Options, Part 2

Editor's note: Welcome to "Booyah Breakdown," an explanation of terms and topics Jim Cramer discusses on his "Mad Money" TV show. Feel free to ask a question if you're confused about something Cramer talks about, but please keep in mind that we do not provide advice on specific stocks.

A few weeks ago, we deciphered the lingo of options traders. So now that you know the code words, let's get in the trading pit and use them.

Remember, we said options are like insurance. The difference here is that your option insurance can actually make you Mad Money.

Today, we'll see how you can use options to protect your current stock holdings. There are two basic strategies you can use -- a protective put and a covered call -- so read on to learn how.

Put on Some Protection

If you own a stock and want to keep it but are worried that something detrimental might happen to the share price, consider a protective put, suggests Tom Boggs, associate director of equity products at the Chicago Mercantile Exchange.

Let's say you're afraid your company is about to announce some bad news, and the stock will take a hit -- or that the upcoming elections are going to hurt share price -- but you still believe in the stock's long-term potential. In those cases, you could consider buying a put to protect your existing gains.

Or if you've owned your favorite stock for less than a year, but want to wait until you have it for a full year to sell it and take advantage of the lower 15% long-term capital gains tax rate, a put could help you secure your profits until that time period is up, says Marty Kearney, senior staff instructor at the Chicago Board Options Exchange's Options Institute.