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+Cl,apter 17: Put Buying in Conjunction with Common Stock Ownership 273 
+The long-term holder who strongly feels that his stock will drop should proba­
+bly sell that stock. However, his cost basis may make the capital gains tax on the sale 
+prohibitive. He also may not be entirely sure that the stock will decline - and may 
+want to continue to hold the stock in case it does go up. In either case, the purchase 
+of a put will limit the stockholder's downside risk while still allowing room for upside 
+appreciation. A large number of individual and institutional investors have holdings 
+that they might find difficult to sell for one reason or another. The purchase of a low­
+cost put can often reduce the negative effects of a bear market on their holdings. 
+The second general class of put buyers for protection includes the investor who 
+is establishing a position in the stock. He might want to buy a put at the same time 
+that he buys the stock, thereby creating a position with profitability as depicted in the 
+previous profit graph. He immediately starts out with a position that has limited 
+downside risk with large potential profits if the stock moves up. In this way, he can 
+feel free to hold the stock during the life of the put without worrying about when to 
+sell it if it should experience a temporary setback. Some fairly aggressive stock traders 
+use this technique because it eliminates the necessity of having to place a stop loss 
+order on the stock. It is often frustrating to see a stock fall and touch off one's stop 
+loss limit order, only to subsequently rise in price.' The stock owner who has a put for 
+protection need not overreact to a downward move. He can afford to sit back and 
+wait during the life of the put, since he has built-in protection. 
+WHICH PUT TO BUY 
+The selection of which put the stock owner purchases will determine how much of 
+his profit potential he is giving up and how much risk he is limiting. An out-of-the­
+money put will cost very little. Therefore, it will be less of a hindrance on profit 
+potential if the underlying stock rises in price. Unfortunately, the put's protective fea­
+ture is small until the stock falls to the striking price of the put. Therefore, the pur­
+chase of the out-ofthe-rrwney put will not provide as much downside protection as 
+an at- or in-the-money put would. The purchase of a deeply out-of-the-money put as 
+protection is more like "disaster insurance": It will prevent a stock owner from expe­
+riencing a disaster in terms of a downside loss during the life of the put, but will not 
+provide much protection in the case of a limited stock decline. 
+Example: XYZ is at 40 and the October 35 put is selling for ½. The purchase of this 
+put as protection for the common stock would not reduce upside potential much at 
+all, only by ½ point. However, the stock owner could lose 5½ points if XYZ fell to 35 
+or below. That is his maximum possible loss, for if XYZ were below 35 at October expi­
+ration, he could exercise his put to sell the stock at 35, losing 5 points on the stock, and 
+he would have paid ½ point for the put, bringing his total loss to 5½ points.