The mere mention of options can send shivers down the spine of investors who have only heard about them through the news.  To be sure, when used imprudently, options can do a great deal of damage to a portfolio.  But, when used prudently, options can be a valuable addition to an investor’s toolbox.  Covered calls are probably the best starting point for adding options to your portfolio.

This is definitely a market in which you need to be hedged. The S&P 500 and the Dow are down about 11% over the past month and only about 2% above earlier January lows. On the other hand, some stocks are doing better than others. Value Line’s rank 1 common stocks are down only about 3.5% as investors are tentatively looking for growth potential. In what may be a “stock picker’s” market, holding good stocks and protecting them with puts may be the way to go. In this week’s report, we cover in some detail how to hedge stocks you own with puts. Even when markets are volatile (as they are now), you can tailor your put insurance to suit your expectations and your tolerance for risk.

If you are already familiar with options (what they are, what gives them value, the terms that describe them and how they are traded), you can probably skip this chapter. However, if you are uncertain about some of the terms or concepts, this chapter will probably answer your questions. We start with some basic definitions.