Large singular stock positions in a portfolio can cause management challenges for the investor. As many found out during the tech bubble a few years ago, holding a large position in one stock can help you learn about lack of diversification the hard way.

I expect large stock positions to begin reappearing in portfolios as the markets and the economy improve, so let’s take a look at several ways one might manage these positions. This article is only relevant to stock positions held outside qualified retirement plans and IRAs, as those accounts/plans have different investing rules and are not constrained by taxes when making decisions to buy and sell.

Setting a “sell stop” at some point below the stock’s current value is a simple strategy for protecting gains. This implies that the investor is willing to sell at some lower price in order to protect gains to this point or cut potential future losses.

A sell stop is an automatic order to the brokerage firm to sell the stock as a market order when the price hits the stop. As the stock moves up in value, an investor can slide the stop up, thus protecting future gains. This strategy works well for stocks with low price volatility. With a highly volatile stock, the investor runs the risk that the price will drop sharply, hit the sell point, trigger a sell and then rebound higher. Thus, the stop must be kept farther away from the current price on volatile stocks.

The investor can also protect against a price drop by purchasing insurance in the form of a “put option” that gives him/her the right to sell stock during the term of the option at a stated price. This works just like conventional insurance, in that the position remains covered as long as the option expiration date has not been reached. At the end of the option expiration, if the investor still holds the stock and requires additional protection, he/she must purchase a new option and pay a new premium.

In both of the above strategies, the investor’s ultimate protection is to sell the stock and pay the taxes. In cases where selling is not an option, for either emotional or financial reasons, the investor may choose to increase income from the position by selling a covered call.

A covered call gives the purchaser the right, but not the obligation, to buy the stock at a stated price from the option writer (owner of the stock). The writer collects a premium and gets to keep it if the option to purchase is not exercised.

A covered call writer typically sells an “out-of-the-money” option with an exercise price higher than the current price plus the premium. If the price stays above that target, there is little risk the stocks will be “called away” or sold at the strike price, and the investor gets to keep the premium. If the price of the stock goes up sharply, risking the sale of the position, the writer of the call may buy back the call and close out his position (generally resulting in a loss) or negotiate the difference between the premium collected and the premium spent to buy back the position.

A word of caution—all option strategies carry risk. It is a good idea to become familiar with option trading by reading books on the subject or consulting a website.