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The Bernanke Put

I have heard market commentators talk about a Bernanke Put and they say this is a reason to believe that stock prices will go up. What are they talking about?

When you buy a put option, it gives you the right to sell a stock at the pre-determined price, called a strike price, at any time before the option's expiration date. It helps you protect a position you might have with a stock if the price should fall.

Because put options give the buyer the right to sell stock at a pre-determined price, it’s like insurance against a market slide. And like insurance, you can pay a premium and buy a put option to protect a capital loss when the share price falls. If the market falls and your share’s price falls, you can sell the put option at the agreed higher value.

Here’s an example. You hold a stock in ABC Pty Ltd and it’s now at $20 a share. Let’s assume you have made good money on the share as you bought it for $13, which means you are up $7. To guard against losing all of your $7 profit, you could take out a put option for $2, which locks in a right to sell the stock at $20 within the prescribed period.

Sure, you have paid $2 or lost $2 in accessing this right to sell at $20 but it could save you a lot if the price dropped to say $10.

In relation to the Bernanke Put, this refers to the US Fed chairman who has promised to use more quantitative easing, or printing money to ensure the US economy grows fast enough to avoid deflation. In a sense, he’s giving share market players ‘insurance’ against a market sell off and by going to great lengths to keep the US growing, companies making profits and share prices rising. And so it’s like a put option.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Friday, October 01, 2010

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