Introduction To A Married Put Options Strategy
A married put is a trade that involves the buying of an at the money put option while buying shares in the underlying stock at the same time. For every 100 shares bought , an at the money put option is bought as well.
Steps
Step 1: Perform economic, fundamental and technical analysis
Step 2: Outlook: Bullish In The Long Term, Uncertain In The Short Term
Step 3: Study the option chain
Step 4: Breakeven Analysis
Step 5: Understand Your Profit Zones
Step 6: Limited loss
Step 7: Loss calculation
Step 8: Potential for unlimited profit
Step 9: Profit calculation
Step 10: Calculate Risk & Reward Ratio
Step 11: Set Up Trade: Executing a married put strategy
Step 12: Exit Trade
Step 13: Record Trade In Diary
Step 1: Perform economic, fundamental and technical analysis
An options trader must perform economic, fundamental and technical analysis before executing the married put. Some of the chart patterns traders should look out for are:
Read: Basic Economic Analysis, Basic fundamental Analysis and Introduction to technical analysis
Step 2: Outlook: Bullish In The Long Term, Uncertain In The Short Term
The investor who uses a married put strategy is bullish on the underlying security in the long term but is unsure of the near term. He recognises that there is a possibility of the price of the underlying security going down in the near term, hence, the ownership of a put option will help to protect against any short term decrease in the price of the underlying security. For example, a value investor who is bullish on a certain company may choose to use the married put. For example, an options trader may understand that an underlying security is significantly undervalued. However, there are headwinds in the form of a weakening economy. This is an example where a married put can be executed.
Step 3: Study the option chain
Next, the trader should examine the option chain to find a suitable option to protect the downside. The put option should have a duration that accounts for the uncertainty in the near term.
Read: Learn to read and understand options chain
Step 4: Breakeven Analysis
The breakeven price point is: Premium paid for put + Acquisition Price Of Underlying Security
Step 5: Understand Your Profit Zones
After the breakeven point is calculated, the trader will have an understanding of the profit zone. A married put is profitable when the price of the underlying security trades above the breakeven point.
Step 6: Limited loss
The loss is limited to the sum of the premium paid for buying the put and the commissions paid to the broker. The maximum loss occurs when the price of the underlying security is less than or equal to the strike price of the bought put.
Step 7: Loss calculation
The loss, if it happens, can be calculated as :
Premiums paid for put + commissions paid to broker
Step 8: Potential for unlimited profit
The potential for profit is unlimited when an investor uses a married put since the price of the underlying security can theoretically go up to infinity. An investor earns a profit when the price of the underlying security is greater than the sum of the acquisition price of the underlying security + premiums paid for the put
Step 9: Profit calculation
The profit can be calculated as :
Price of the underlying security – Acquisition price of underlying security – premiums paid for put.
Step 10: Calculate Risk & Reward Ratio
If a trader has done economic, fundamental and technical analysis, he will have a price target at which he will exit the trade. Hence, the trader should calculate the risk and reward ratio. The trader must find out the amount of potential reward for every dollar of risk taken. The risk and reward ratio must be attractive enough for the trade to be undertaken.
Read more: Understanding Risk/Reward Ratio For Option Traders
Step 11: Set Up Trade: Executing a married put strategy
- Buy 1 ATM put option
- Simultaneously buying 100 shares of the underlying security
Step 12: Exit Trade
If the trade is reasonably profitable, the trader may wish to exit the trade immediately or gradually as the price of the underlying security rises.
Step 13: Record Trade In Diary
After the trade has been exited, the trader should detail the trade in a diary, analysing his performance and reflecting on it. He should find ways and means to improve on the trade.
Example Of A Married Put
ABC company is trading at a price of $30. You buy 100 shares of the company and buy a current month December 30 put at the same time as you are unsure of the near term price fluctuations. You believe that in one year’s time, the stock price of ABC company will trade at $50. It is currently trading at $30 because of negative news that it had to do a recall on one of its products among the many consumer products that it manufactures. The market has overreacted to the news which has caused the company to trade at 52 week lows from a high of $80.
Since there is no way that you are able to tell if the price of the company will continue going down after buying it at $30, you decide to buy a 1 near term put option contract which is at the money which cost $1.
If the price of ABC trades at $20 at the expiration of the put option, the put option can be sold for $1000 as it is $10 in the money. Since your bought it for $1, you have made a profit of $1000 – $100 = $900 on the put option. However, you made a loss on the underlying security which is equal to ($30 – $20) x 100 = $1000 In total, your loss is $1000 – $900 = $100 which is the premium paid for the put.
If the stock happens to trade upwards to $40, you would have made a profit. That profit can be calculated as : ($40 – $30) x 100 – $100 = $900
Study Comparable Strategies
The long call and the protective put have similar payoff profiles to the married put.