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The Married Put Option Strategy: The Smartest Way to Protect Against Downside
by Karim Rahemtulla, Options Expert
Tuesday, November 3, 2009: Issue #1129
Here’s the situation… We have an uncertain, volatile stock market that can’t figure out its next move.
Thanks to the rally for much of this year, many investors have recovered a good chunk of what they lost in 2008. Some are even sitting on some big profits in a few positions.
What do you do now?
Some investors will lock in their gains and retreat to the sidelines. Others will stay invested and take their chances.
Whose approach is right?
Neither. There’s a better way to protect your profits without selling anything, and you can do it by executing a married put option strategy. Here’s how it works…
The Art of Put Options
Put options primarily used to accomplish two things…
- Selling stocks: When you buy a put option, you have the right, but not the obligation, to sell a stock at a certain price (strike price).
- Buying stocks: When you sell a put option, you’re obligated to buy the underlying stock at the designated strike price, as long as the shares are trading below that strike price.
Today, we’re going to focus on the buy side.
Let’s say we bought Intel (Nasdaq: INTC) for $13 back in March. Today, we’re sitting on a $6 profit.
In a market like this, that gain could evaporate in a hurry. Alternatively, it might not if the market heads higher. So we’re stuck, right?
Well, no.
Most ordinary investors would employ a simple 20% trailing-stop from current levels, meaning they’d sell the position if the stock falls by $3.80. An important admirable strategy in order to protect profits, or limit losses – and one we frequently preach here.
But what if you could actually protect your downside for less money for a pre-determined period of time?
How to “Marry” Your Stock Position With a Downside Hedge
If you buy a put option, you’re hedging against downside on the underlying shares. So if the stock declines, the option will increase in value. On the other hand, the option will decline in value if the stock rises.
But at no time will you risk losing more that what you paid for the option.
So let’s say we expect the market to be rocky for the next six months. Here’s what we could do…
~ Buy the Intel April 2010 $19 puts (at-the-money), trading for about $1.90 per contract.
This means that if Intel falls below $17, we’ll start making money on the put option (remember, we have to subtract the price we paid for the option). We’ll make more money if the decline occurs sooner, since the amount of option premium allocated to time and risk would increase, especially the risk component.
When we buy this option, we’re essentially saying that we’re willing to give up $2 in profit (the cost of the at-the-money option you bought) in order to protect us from any fall in price below that.
It also means that we’ve added $2 to our cost in the position (consider it insurance). If Intel moves the other way and heads into the $20s, we’ll lose 100% of the amount paid for the option if Intel closes above $19 by expiration, but we will still participate in the upside of the share price move. However, we could sell the put earlier to recoup some of the cost if a clear uptrend is evident.
The Married Put Option Strategy
This type of option trade is known as a married put, where you buy a put option against shares that you own.
While this trade is just an example, you could execute the married put strategy today if you wanted to. Just buy Intel at $19 and buy the April 2010 $19 put option against the position for $1.90 and you achieve two things…
- You’ll establish an automatic stop-loss of $1.90 that will be in place until the April expiration.
- For about 10% of your cost, you’ll protect your downside completely. Not an expensive proposition in a market like this one.
And remember, the most you can ever lose when you buy an option is the amount you spent on the option.
Good investing,
Karim Rahemtulla
Editor’s Note: The married put strategy has already played out perfectly with Intel in the Xcelerated Profits Report.
- In the February 2008, Lee Lowell advised readers to sell the Intel January 2009 $15 put options for $1.75 per contract.
- When assigned the shares in January, it dropped the cost to $13.75.
- To protect against downside, readers bought the January 2010 $20 puts in August.
So in addition to current gains of 37%, investors are now protected against the downside and have the right (but not obligation) to sell Intel for $20 at expiration. For more information on how to execute easy-to-use, professional strategies that can significantly reduce your risk while also boosting your upside, take a look at the Xcelerated Profits Report today.
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5 Responses to “The Married Put Option Strategy: The Smartest Way to Protect Against Downside”
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Karim Rahemtulla is one of the country’s foremost specialists in options trading and Investment Director of Mt. Vernon Research, as well as the founder and editor of Strategic Income, The 400 Report and Investment U. 
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November 3rd, 2009 at 12:45 pm
By buying the put you are going to give up $2 of your profit for sure. Why not do what you recommended a while ago and sell an in the money call – like the Intel April 17 call? You get the premium of $2.48. If the stock goes up you will lose the stock for $17, which is then a $1.52 loss – less than a $1.90 loss. If the stock drops below 17, you keep the stock but get the $2.48 and can sell the stock so it is likely that you could get about the same as if you sold the stock now at $19. Better yet, if you really believe INTC will drop $2, sell the stock and buy a put with $1.90 of the proceeds. You keep your INTC profit and can probably sell the put for more than $1.90 prior to expiration.
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Investment U Reply:
November 3rd, 2009 at 2:18 pm
Bob,
Yes, what you have said is a valid strategy, but may be too complex for many people. In this market, direction is the issue. By employing a married put, you not only protect your downside but you allow for unlimited upside as well. My objective at Investment U is to show people all types of strategies that may fit their needs. Thanks for your response.
Karim
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November 3rd, 2009 at 1:20 pm
Karim – Buying put options on your stock may be a hedge, but if you bought that INTC in March, you still have 5 months to go to get that 15% Long Term Capital Gain treatment. BUT the IRS says that if you buy a PUT option on a stock on which you have NOT achieved LTCG status, you RESET the IRS clock to zero!
Much better is to buy a Put option on the Semiconductor Index, SMH, or the Technology Index, XLK, which does not affect your LTCG status.
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November 3rd, 2009 at 8:43 pm
I don’t know … even though I have a Ph.D., I have trouble understanding the ‘puts’ and the opposite moves. And now, you give us a ‘married put’!!! Of course, maybe my age is against me. Thanks for all the info.
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November 4th, 2009 at 9:40 am
The married put option is very good advice.
However, did you mention what happens if the stock
stays basically unchanged?
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