Smart options strategies can help even conservative investor in down market

Options volume is hitting all-time highs this year, partly because more individual investors are trading them.

According to the Options Industry Council (OIC), volume in the first half of 2008 rose nearly 40 percent to 1.74 billion contracts.

Randy Frederick, director of derivatives trading at Charles Schwab & Co., estimates that about half of the growth in recent years is due to hedge funds and retail traders.

An April survey of 500 Schwab active traders, or those who make at least 36 trades a year, showed that four in 10 regularly buy and sell options. Among those, 95 percent say they will maintain or increase their options trading in the next six months, the survey found.

But you don't have to be an active trader to benefit from options strategies, and one conservative play could be particularly useful in a falling market.

Buying a protective put, or the right to sell a stock holding at a specified price during a set period of time, preserves the profit potential of stock ownership, while limiting downside risk.

Many traders set "stop-loss" orders to limit losses or to lock in gains if a stock falls, but Frederick says there are advantages to using a protective put instead.

"With a stop order, a gap open can really hurt you. You can get filled well below where a stop order is placed," he said.

This "gap" can be in reaction to disappointing earnings or another event that causes a stock to open much lower than where it closed, triggering an automatic sale below what was initially intended. But a protective put can still be exercised at the prescribed price.

Frederick says investors considering trading options should get educated.

He recommends resources from the OIC, such as the book "An Investors Guide to Trading Options" and tools on the council's Web site, www.optionseducation.org.