For items you value most, you generally buy insurance. Whether a home, a car, or your own health, buying insurance makes sense. But what about your retirement nest-egg or your trading portfolio – have you insured them?
The married put options strategy is a way to insure stocks in your portfolio. A nice feature of the married put is your downside risk is limited, but the upside potential is unlimited – the higher the stock goes, the more money you make.
Like any insurance policy, you don’t want to pay for it when you don’t need it because the sum of the premium charges can be costly over time. But every so often, stocks will undergo major declines and, during those periods, married puts can not only help to protect against large portfolio losses but also bring peace of mind by limiting your downside risk.
Table of Contents
- How To Buy Stock Insurance: The Married Put
- Married Put Basics
- How To Lower Risk Using A Married Put
- Why The Married Put Is A Powerful Options Trading Strategy
- Why Doesn’t Every Stock Trader Buy Married Puts?
- How To Calculate Married Put Risk & Reward
- Best Married Put Options Brokers
- Can Married Puts Be Used In Retirement Accounts?
How To Buy Stock Insurance:
The Married Put
Married puts have limited risk and unlimited upside potential but you must pay for the insurance protection. Covered calls have much greater downside risk and limited upside potential, but you get paid a fixed amount to start the trade.
When you have maxed out those retirement account contributions, you may deposit extra savings into a brokerage account and invest the proceeds so that your hard-earned money makes more money for you.
The fruits of your labors are contained in those retirement and brokerage accounts, so it makes sense to intelligently protect your savings. And that’s where the married put comes into play: to limit your portfolio risk.
Unlike a covered call options trading strategy that puts money in your pocket, a married put will require you to take money out of your pocket. You are buying insurance after all, so it will cost you a premium to protect your portfolio for a specific time period.
Like a covered call, a married put is one of the simplest and best options trading strategies. But the two strategies have very different purposes. The covered call limits your upside potential and enables you to produce an income income while the married put limits your downside risk and requires you to pay for portfolio protection.
If you expect a stock to fall a lot, a covered call won’t offer much hedging whereas a married put will protect your holdings very significantly, and the added bonus of the married put is that the opportunity to make money if stocks bounce higher is unlimited.
>> Learn Options Trading Basics
Married Put Basics
Married put options strategies reduce risk compared to holding a portfolio of stocks alone but the cost of buying put options regularly can become expensive over time, so the strategy should be used occasionally when risk is high.
The married put options strategy is simple and powerful. To create a married put, all you need to do is buy 1 put option contract for every 100 shares of stock you own – because generally 1 option contract corresponds to 100 shares of stock.
When you buy the put, you acquire a right to sell stock at a fixed price for a specific time period, no matter how far the stock may fall. Even if the stock were to drop all the way to zero, the put option(s) you purchase gives you the right to sell your stock at a pre-agreed price for a fixed duration until the option expires.
Say you own 100 shares of stock, which is trading at $53 per share and you are concerned the share price may fall. Perhaps the general market is moving lower or a negative quarterly earnings announcement is released. Whatever the reason, you want to protect your stock, so you buy a put option at say a strike price of 50.
Purchasing a strike 50 put option will cost you upfront. Let’s say the premium payment costs you $3 per share, which amounts to $300 per contract. After buying the put, your stock is protected, so you can have peace of mind that no matter how low the stock goes, you can always sell your stock for $50 per share.
WHEN TO BUY PROTECTIVE PUTS?
Options traders will sometimes buy put options before major company announcements, especially when the share price is expected to be volatile.
In this example, if a put option was purchased and the stock subsequently fell to $30 per share, you could still sell the stock for $50 per share by exercising your right to sell the stock. This right comes at a cost, which is the price paid for the put option.
So, if the stock fell all the way to $30, you could avoid a big loss on the stock, but you would lose the $3 premium you paid for the put option. All in all, it’s a good tradeoff, and you end up avoiding a big stock loss by choosing the married put strategy – but keep in mind the insurance protection is not free.
These costs mount up over time if you choose to insure your stocks regularly. For example, if you pay $3 for a put option to protect your stock over the next few months, it might initially seem inexpensive. But if you keep buying put options, the sum of the costs can accumulate in a hurry. Repeat the strategy each quarter and the total insurance cost would be $12 annually, which is over 20% of the value of your stock!
Because premium costs when purchasing put options accumulate to a sizable amount over time, it is best to buy a married put(s) judiciously when needed most.
How To Lower Risk
Using A Married Put
Married puts limit risk substantially compared to holding stock alone. The risk is limited to the difference between the total cost of the stock plus the put and the strike price of the protective put option.
If you own the stock in the example above priced at $53 per share, the risk is the full $53 because if the stock falls to zero, you could theoretically lose your entire shareholding.
In practice, this is highly unlikely, especially if you are holding the stock of a solid company, such as Autozone with a multinational retail footprint. Still, the risk can be large, especially when the overall market sentiment is negative. The married put options strategy can reduce that risk considerably, but by how much?
Using our example above, if the stock is trading at $53 per share, and the put option is purchased at a strike price of 50 for $3 per share, then the overall cost basis for the position is calculated as follows:
Cost Basis = Purchase Price of Stock + Purchase Price of Put Option
Cost Basis = $53 + $3 = $56
The risk is calculated as the difference between the cost basis and the strike price. The reason for this is that when the stock moves below $50, you can at any time exercise your right to sell the stock for $50.
The risk in this married put example is just $6 per share, which is calculated as follows:
Married Put Risk = Cost Basis – Put Strike Price
Married Put Risk = $56 – $50 = $6
These are all per share figures, so if you want to calculate the total dollar risk it is generally the per share figure multiplied by 100, because each contract usually corresponds to 100 shares of stock.
In this example, the risk is $600 when 100 shares of stock is owned and 1 put contract is purchased.
If you were to own 1,000 shares of stock, then 10 protective put contracts could be purchased, and the risk would increase accordingly by 10x to $6,000.
As a stockholder, the decision you need to make is whether it is worth paying for the put option(s) to limit the risk versus holding the stock alone. If 1,000 shares of stock were owned with no protective put hedging, the risk would be $53,000.
So, if you are concerned the stock may fall a lot, it is worth seriously considering paying a comparatively small amount to very substantially limit the amount you could lose.
But if you think the stock will fall, why not just sell it? Why buy put options and limit the downside risk when you could completely eliminate risk by offloading the stock and going to cash?
Why The Married Put Is
A Powerful Options Trading Strategy
When a stock falls sharply and rebounds to original price levels, a married put strategy has the potential to significantly lower cost basis compared to a buy-and-hold strategy.
At first glance, it might seem like the smarter decision when holding stock that you fear will fall is to sell the stock. But it turns out the married put is one of the most powerful options trading strategies a long-term investor can use to maximize portfolio returns.
To highlight how to use a married put to your advantage over the long-term, consider the example of the stock above where it falls from $53 to $30, and subsequently bounces back to $53.
Assuming you have purchased the put option at strike 50 as above, you have two options when the stock falls from $53 to $30.
- Exercise your right to sell the stock at $50 per share; or
- Sell the put option for a profit, and continue holding the stock
Earlier, we considered only the first option, whereby we exercised our right to sell the stock. When we did so, we lost money both on the stock and the put option.
Exercising the put option cost us $3 per share – the premium we paid for it. And because we bought the stock for $53 and sold it for $50, we lost $3 per share on it too, for a total loss of $6 per share overall.
But another choice might have been more lucrative. Instead of exercising the put option and selling the stock, which triggers a taxable event, you can instead simply sell the put option for a profit.
With the stock at $30 per share, the strike 50 put option is worth at least $20 (the difference between the strike price, $50, and the share price, $30). Since we paid $3 per share for the put and it is worth $20 per share, the profit is $17 per share.
Now fast forward to a time in the future when the share price has gone on a round trip from $53 to $30 and back up to $53.
A buy-and-hold investor would have suffered a lot more heartache as the stock fell because their downside risk is much higher than that incurred by a married put trader. And when the stock returned back to $53 per share, the buy-and-hold investor returned to a breakeven level.
Compare the result for the married put options trader, who is also at breakeven for the stock position, but has pocketed $17 per share in put option gains too.
The benefit of choosing the married put strategy has been to lower the net cost basis by $17 per share.
For this reason, savvy options traders don’t view stock market corrections as negative events but rather opportunities to effectively lower overall cost basis more quickly than could otherwise be achieved.
Of course, the stock must bounce back in the end for the strategy to pay off, so if you think a declining stock won’t ever recoup its losses than the married put won’t be as effective over the long-term at lowering cost basis, but it will still limit risk substantially.
>> Discover The Best Options Trading Strategies: The Covered Call
Why Doesn’t Every
Stock Trader Buy Married Puts?
Options are affected by time-decay, which erodes their value by a fixed amount each day. Buying put options is effective when you expect a share price decline but if you hold them when stocks are stable or rising, the sum of the premium payments can hurt your portfolio value over the long-term.
If married puts are so good, why doesn’t every stock trader use them to limit risk and hedge against stock market declines?
As it turns out, not every buy-and-hold investor is even aware of the married put strategy or how to employ it. And many who do know of it still prefer to roll the dice by holding a declining stock rather than taking money out of their pockets to buy put options.
They engage in a buy-and-hope strategy, praying the stock will recover despite share price declines which act as evidence to the contrary.
Nevertheless, it is generally not a smart strategy to buy put options regularly. If you buy puts on stocks that don’t fall but instead stay fairly flat or rise, the put options will decline in value and act as friction, slowing your portfolio growth, and eating away little by little at the stock gains.
Options prices are subject to a factor called time-decay, which erodes the value of the option a little each day until the option expires. Unlike a stock which you can hold forever, an option has a built-in decay rate which causes it to decline in value each day, all else being equal.
So, the married put options strategy is powerful and effective when
- limiting risk when the stock is falling; or
- when you anticipate the stock to fall and want to hedge.
But it is not a strategy to use all the time; otherwise the sum of the put option contract costs will hurt your portfolio value over the long term.
How To Calculate
Married Put Risk & Reward
The risk in a married put options strategy is limited to the total you pay for the stock plus the put option minus the put strike price. The reward potential is unlimited; it’s as high as the stock can go.
The most you can lose in a married put strategy is limited to the total amount you pay for the stock plus the put minus the put strike price.
Stock Price: $53
Strike 50 Put: $3
Cost Basis = Stock Price + Put Price = $53 + $3 = $56
If the stock goes higher, the put will decline in value but you cannot lose more on the put option than what you pay for it.
So, if the stock rises to say $100, you will make money on the stock and will lose no more than $3 per share on the option.
Risk = Cost Basis – Put Strike Price = $56 – $50 = $6
Even if the stock were to fall to zero, the most you could ever lose is the risk, which is limited to $6 in this example.
The upside potential or reward potential is unrestricted when you enter a married put options strategy. Theoretically, the stock won’t go up forever of course, but unlike a covered call, which has a profit ceiling, a married put continues to make money with ever higher share prices.
Best Married Put Options Brokers
Married puts are among the simplest of all options trading strategies, and any broker or trading platform worth its salt will be able to easily handle trade executions.
TastyWorks is the newest of platforms, but has perhaps one of the most experienced options trading teams in the industry; many of the team members were also involved in building thinkorswim, which earned a reputation as one of the very best platforms for options traders.
The industry’s pioneering options platforms, thinkorswim and OptionsXpress, were both acquired by major brokerage firms, TD Ameritrade and Charles Schwab, respectively.
All of them offer competitive commissions rates, though TastyWorks has pioneered an alluring fee structure where closing contracts incurs no commissions costs.
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via tastyworks secure site
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Can Married Puts Be Used
In Retirement Accounts?
Married puts can be used not only in brokerage accounts but also in retirement accounts.
In a non-retirement account, when you exercise a put option and sell stock, you may be liable to pay taxes on any capital gains (short-term or long-term capital gains taxes).
However, when you exercise puts to sell stock in a retirement account, such as a 401(k) or traditional IRA, which most good options brokers allow you to do, you will not incur the same tax consequences because taxes are deferred until withdrawals are made.
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