How do you protect your stock portfolio from a possible crash when the market is hitting record highs? One option is to use an options strategy. Specifically, it involves a “protective put option contract.”

An option contract gives you the right to buy or sell shares of a stock or exchange-traded fund (ETF) at a specific price in the future regardless of the actual price on that date. With a put option, if a stock you own sinks, at least you know exactly what your lowest selling price could be months from now.

What you get: You are effectively setting a limit on the maximum amount you can lose if your shares fall below the option contract’s preset price, also known as the “strike price.”

Example: You own 500 shares of the SPDR S&P 500 ETF (SPY), an ETF tracking the Standard & Poor’s 500 stock index, selling for $165 per share in late August 2013, worth a total of $82,500 at that time. You are worried that the next several months could be scary for the market and that you can’t stomach a loss of more than 10%, or $8,250. In this case, you could ask for March 16, 2014 protective put option contracts that allow you to sell your holdings for $148.50 per share (10% below the current price) at any point up to the expiration of the option contracts. (You typically can buy an option with an expiration date anywhere from a week to 18 months.) Even if your ETF drops by, say, 50%, the most you will lose is $8,250 rather than $41,250.

What happens if the market rises in the future and your ETF’s value is above the initial $165 per share? Since your contracts don’t obligate you to sell your shares, you simply let your put options expire and enjoy the profit. Of course, the drawback is that if your ETF still is trading at $165 per share or slightly below when the options expire, you paid for coverage that you didn’t really need.

How much options cost: You pay the seller a “premium,” which varies depending on not just the length of time and number of shares but also factors such as the current volatility of the market and how much your stock or ETF is trading for. In late August, the premium in the above example would be about $4 per share, or a total of $2,000.

Also, your brokerage firm will charge a commission to assist you in buying a put. (Buying it electronically without assistance involves a much smaller fee.)

Typical commissions range from about $21 at Vanguard and $30 at Merrill Lynch to about $33 at Fidelity and $45 at TD Ameritrade. In addition, you usually are charged 75 cents per contract. A contract covers 100 shares.

The brokerage firm will match your request with a seller through an options exchange, typically the Chicago Board Options Exchange. (You can research available options yourself at

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