Options Strategy

Whether you credit a Santa Claus rally, an early January Effect, or some other driving market force, there's no disputing the strong finish posted by stocks in 2011 - or the healthy 2012 opening advance added in the first week of January.

To be specific, stocks - as measured by the Standard & Poor's 500 Index - rose from 1,204.00 at the close on Monday, Dec. 19, to 1,257.60 on Friday, Dec. 30, then jumped to 1,280.15 at midday yesterday (Monday), a gain of 6.32% in just three weeks. The Dow Jones Industrial Average did almost as well, climbing from 11,751.96 on Dec. 19 to 12,398.29 in Monday trading, a 21-day gain of 5.50%.

While those short-term moves are certainly impressive, they're hardly unique in today's volatile market environment. Three similar advances have occurred in the past five months alone - in late August, early October and late November - but each was followed by a sharp short-term pullback that wiped out much of the value gained in the rallies.

And, while few things in the market are certain, there's a strong probability this current market advance will also be followed by a sizeable retracement in the very near future.

So, how do you protect your most recent gains?

One answer is to turn to the options market.

A Defensive Options Play

As veteran Money Morning readers know, two of the most effective and often-used strategies involving options are writing covered calls to bring in added income and buying put options as "insurance" against possible price pullbacks.

As such, investors would typically look to the latter strategy - buying puts - for protection in the present market situation. However, there are times when unusual conditions can force investors to take an alternative approach to option strategies - and that has certainly been the case recently, thanks to the market's extreme short-term volatility.