There are a few trading tactics you should familiarize yourself with before going short with put options.
* Timing: More so than with a long position, time is money. So unlike with typical long positions, it’s imperative that you set time horizons for short-side investments and try to stick with them. I know I am repeating myself, but I consider this so important that it is worth the double entry: Make sure to set up an investment horizon for each short position.
* Edging In: Technical movements in stocks are much more important on the short side than for a longer-term investor. If a stock is bouncing around, you can edge into your put-option positions with small purchases within a price range, not at one fixed price. For example, if a Merck () put for a certain date is $4, but for the past few days it has traded between $3.80 and $4.20, be patient. Nibble and get some at $4, but also put in bids for $3.90 and $3.80 and see what happens.
* Rolling a Position: This is a critical tactic for managing a successful position to maximize profit and minimize risk. Let’s say you did buy those Dell $40 put options and they went from $3.50 to $12.50 — but you think the stock is going to sink even more. You would sell the puts for $12.50, pocket the profits for another investment or trade, take your initial investment and reinvest it in a call at the $30 strike price with the same or a later exercise date.
This is called rolling a position — and one reason to do this is to manage a position that is not working. It serves to minimize risk by periodically pulling profits off the table without abandoning the position entirely. You can also use rolling to ride a stock that is on a continuous slide, whereby you are stopping to take profits along the way and initiating newer positions that give you greater leverage.
* Hedging: Some people get silly and end up with too much money on the short side. If you find yourself in that position (and I hope you do not!), you should hedge your exposure against a big market upswing through the purchase of call options on the S&P 500 — just enough to protect your short positions against unforeseen circumstances, like the president of Iran going back to Mars or the Federal Open ÃÛÌÒ´«Ã½ Committee cutting interest rates by 200 basis points.
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