A:

Short selling really isn't a form of insurance. It is the opposite of going long or buying a stock with the hope that the price increases. Short sellers hope that the price of the stock they are shorting goes down. Short selling is more like taking an outright position rather than insurance.

Put options are related to short selling, but it's more like a form of insurance. Put options give the owner the right, but not the obligation, to sell 100 shares of stock per contract at a set price for a set period of time. The price is known as the strike price. Standardized option contracts are traded on the Chicago Board Options Exchange (CBOE) and other exchanges for several different future dates and strike prices.

Buying a put option costs the buyer a premium. If the price of the stock goes down, the value of the put option increases. The owner of put options profits if the price crosses below or stays below the strike price. The owner has the choice to either sell the option for a profit or exercise it and sell the stock for a profit if it is below the strike price. A 100-share put option for a stock would offer insurance-like protection for 100 shares. Using put options as insurance in this way is known as hedging.

Also involved with buying options for insurance or hedging purposes are commission charges and slippage. Commissions are quite reasonable, with standard option rates near $5 for most investors in 2015. Most equity options markets have a 20- to 30-cent bid/ask spread that equates to paying an additional $20 to $30 per contract. The spreads on some contracts may be as wide as $1 or more. Many options players are outright speculators with no underlying position that they are hoping to insure.

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