Can't you just hear the InBev executives at the board meeting shouting, "This Bud's for us!" The Belgian company has made the cool beverage maker's stock hot. If you own BUD, your frosty mug runneth over. Time to hedge.

The option solution in this situation is simple. Buy puts to protect the stock holdings. When a person buys 1 put per 100 shares of long stock, the position is called a married put. It is also, technically speaking, a synthetic long call. No matter how you look at it, the upside remains unlimited, while the downside risk is confined to the premium paid for the put option (assuming the put was at-the-money when purchased.) The higher the strike price you use, the more upside you'll give up. However, your downside protection will be more effective and ultimately cheaper because the time value component is reduced for put strikes above the at-the-money strike. Put strikes lower than the at-the-money strike will also have less time value and offer cheaper protection, but the protection will be less effective; that is, potential for loss will be greater. Of course profit potential will also remain greater if a put strike below the money is chosen.

Under situations like this, options become very simple and practical. Buying a put option to protect gains on a highly and rapidly appreciated stock satisfies both your greed and your fear.

Cheers.

Take your free trial of ChartBender Pro!