Married Put Strategy

Married Put Strategy: Your Go-To Options Insurance When Times Are Good

By Jim Stanton, Contributing Editor
Tuesday, May 2, 2006: Issue #305

The S&P, the Dow, the Nasdaq… Almost all of the stock indexes are at the highest levels we’ve seen in years. At this point, the average investor might take the plunge – buy a stock he likes and hope the rally continues. This, of course, worked for everyone in the late 1990s, as even the novices were cashing in.

But that was an exceptional time in the markets. A savvier investor may see the market as overbought in the short term, and may wait to buy the stock on a pullback toward a support area. In a market like this, however, there is a good chance that won’t happen, at least not now. And the stock you were thinking about buying on a pullback may keep moving north.

For short-term and day traders, this is not a problem, because good ones will be out at the first sign of weakness. But, if you’re looking to hold the stock for the intermediate to long term, despite any short-term volatility, there is one option strategy, I use that alleviates the fear, which is half the battle, and allows you to get a peaceful night’s sleep no matter how volatile the market gets. Here’s how using the married put strategy works…

Let’s Get Married To Put Options!

There are different terms for this strategy, but the old-timers refer to it as a “married put.” Married puts refer to the combination of two different purchases – that of a stock you wish to own and of a put option on the same underlying stock. Consider the following purchase…

Say you choose to buy 100 shares of XYZ Corporation for $30 per share and one XYZ June 2006 $27.50 put for $1 (100 shares x $1 = $100). Using this combination, you have purchased a stock position at a cost of $30 a share, but have also bought a form of insurance to protect yourself in case the stock declines below $27.50 before the expiration (third Friday in June 2006).

The term “married” is used because both transactions have to be done simultaneously (in the same day) and you must tell your broker that the stock you have bought is to be delivered if the put gets exercised.

Obviously, you can’t use the married put strategy on every stock you buy, because over time, with the cost of the option and extra commissions, it can erode your overall portfolio’s return – sometimes significantly. Under certain circumstances, however, it can be very beneficial…

Limit Your Downside With Married Puts

It’s very useful when a stock or the indexes “appear” extended, but it can also be used anytime with volatile stocks, or if you want to take a chance just before an announcement or earnings release. By using a married put, your downside is limited – very appealing, considering the recent market conditions.

When you do use this married put strategy, your potential gains or losses are derived from the net effect of the long position in the put and the underlying stock. This is an insurance strategy that allows unlimited upside potential while simultaneously limiting the potential loss. If the stock price stays above the option strike price, the option will not be exercised and the investor can sell the stock at a higher price and take profits, as long as the underlying stock price is above the total cost of the position.

Time Is On Your Side Using Married Put Strategies

If the stock price should drop below the strike price around the expiration date, the investor would exercise the put option and sell the stock at the strike price. You would not have to exercise the put until just before expiration day, so if the stock does drop below your strike price prior to expiration, time is actually on your side in this situation – a rarity for the option buyer.

With that extra time, this married put strategy can still work out as planned because the stock has a chance to move back above the strike price before any action is necessary.

My own research suggests that there is a good chance of a serious correction on the horizon, as often happens going into the mid- term elections, and on a relative basis, puts are cheap insurance right now. The Volatility index (VIX), which is directly correlated with option premiums, is near a three-year low, which makes this married put strategy look even more attractive right now.

Good Trading,

Jim Stanton

One Response to “Married Put Strategy: Your Go-To Options Insurance When Times Are Good”

Madan Says:
November 7th, 2009 at 9:51 pm
The covered call and selling put option appears same in terms of risk and reward. What is the difference in ur opinion. Please clarify. Thanks

Reply

Comments

**By submitting your comment you agree to adhere to our Comment Policy and Privacy Policy.

Check out our selection of daily Investment Research: