Derivatives Trading with Married Put Options - AxisDirect
Jan 22, 2018 | Source: Investopedia
Securing Stock Investments with Put Options
Married Puts are used to protect your investments while trading in derivatives. In terms of their function and their price movements, puts are essentially the opposite of calls. When the price of the underlying equity begins to fall, the value of a put option on that stock will begin to rise. Often brokers will provide the ability to write covered calls and to use married puts when you open your options account.
Married puts refer to the combination of two different purchases: one of a stock position and one of a put option. Let's consider the following purchase. Let's say you choose to buy 100 shares of XYZ for ₹20 per share and one XYZ September ₹17.50 put for ₹0.50. With this combination, you have purchased a stock position with a cost of ₹20/share but have also bought a form of insurance to protect yourself in case the stock declines below ₹17.50 before the expiration. You should remember that for a put to be considered "married," the put and the stock must be bought on the same day, and you must instruct your broker that the stock you have just purchased will be delivered if the put is exercised.
Does a Married Put Make Sense?
When you actually think about it, why would anyone ever choose to employ this particular strategy? Some of you might think that it's almost like buying a stock and knowing that it will fall to pieces! That is an interesting argument, but a married put should be looked at as a form of insurance rather than as an expectation of a certain outcome. In essence, you are expecting an appreciating stock price, but you are also preparing yourself in case your stock takes a steep plunge.
Obviously, you can't purchase put protection for every stock in your portfolio because such costs would significantly eat into your portfolio's returns over time. You can, however, use a married-put strategy in certain circumstances - particularly if you are unsure about a certain stock. How many times have you bought a stock only to slap your forehead in disgust when reading a quote a few days later? With a married put, your downside is protected - an idea that is quite appealing in today's market.
Consider the following example. Today is January 1 and you purchase 200 shares of ABC at ₹10/share and two February ₹9 puts for ₹0.25 (₹25 per contract). You have also told your broker that you intend for this to be a married put transaction, so let's consider whether this position makes for a good trade.
In any transaction, you have to gauge your exposure, or your risk. In the given example, you have a total cash outlay of ₹2,050. You have paid ₹2,000 for the stock and ₹50 for your insurance policy. If the stock goes up above ₹10.25, you are now in a profit position on paper and won't have to consider the put option because it will expire worthless. If, however, ABC plummets to ₹6 a share, then the value of the insurance quickly becomes apparent. If you were faced with a stock value of ₹6 at the February expiry, you would be looking at a loss of ₹250 (200 X [10.25-9.00]). Contrast this with the loss you would have incurred without the married put strategy: ₹800 (200 X [10.00-6.00]).
As you work through the example, it becomes obvious that a married put makes a lot more sense for an investment in which you expect an event to raise the price significantly, which, if left undelivered, will result in a dramatic fall. Such a situation might be an upcoming earnings release date, when the company will either deliver positive cash flow or lose its credibility completely. In such a case, a married put can protect your downside while allowing you to participate fully in any upside (unlike a covered call, which limits your potential gains).
Things to Consider
If you are new to options, your broker might limit your exposure to puts by confining you to married put positions. Because two investments are tied together, you will be sure to have shares available if the put is exercised. Furthermore, unlike a covered call, a married put does not increase the value of your portfolio over time - because you are buying the put option, you are incurring a cost for the price of this protection. Any costs, whether they are trading fees, insurance, commissions or management expenses are all factors that lower your return. This is an important point to remember when considering put options for your portfolio.