How to Use Options to Protect Your Portfolio

NEW YORK (TheStreet) -- Options are investment tools that can be used in a variety of ways. While many professional traders use them for speculation, they can also be powerful hedging tools when applied properly.

Basically, options are contracts that give buyers the right, but not the obligation, to buy or sell a stock or security at set price at a future date. Listed options are available for most actively traded stocks and ETFs today.

If you have a stock or ETF that you want to protect for a certain amount of time, options can be one way to achieve that. For example, you may have a position that you want to sell, but don't want to liquidate it in the current calendar year for tax reasons. Selling it next year would be better for you but you're afraid of the stock losing value. Perhaps you want the money for specific purpose, like a home purchase, helping someone with college tuition or starting a new business.

Another time investors use hedges are for upcoming economic events on the calendar. Maybe you're concerned about an earnings report on a particular stock. Or there's a Fed meeting and you want some protection during the announcement in case of an adverse market reaction.

Understanding how options work in these circumstances can help you decide what's the best strategy for you. Keep in mind though, that options are not suitable for all investors, there is risk involved and they can be complicated to execute. There is also the potential for large losses when not done properly. You should read the options disclosure document on the Chicago Board Options Exchange Web site for more information.

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