Options - Married puts

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A married put is formed when an investor buys shares (increments of 100 or commensurate amount) of a stock and simultaneously buys the corresponding put option contract. See SEC definition of a married put in Section II of the following: [1]

Why Use Married Puts?

The married put has the benefit of "insuring" a stock for a predetermined length of time; that is, in the event that the price per share of the stock falls below the strike price of the put contract, the owner of the shares may exercise the right to sell the shares at a specific price known as the strike price. Assuming that the strike of the put was below the price of the stock at the time of purchase, the exercise of the put option allows the speculator to limit the loss of the play. If the price per share is at or below the strike price of the put option at expiration, the broker may auto-exercise that right. If the stock remains above the strike price through expiration, the owner is under no obligation to sell and the contract usually expires worthless.

The upside, or potential gain, is theoretically unlimited (albeit reduced by the cost of the put). When compared to the outright purchase of shares without the purchase of puts, the former strategy outperforms the latter by the cost of the put(s) with commissions etc. On the other hand if the price of the stock in question falls, the loss is limited to the cost basis of the stock minus the strike price plus the cost of the put plus commissions etc. A trading tactic such as a stop-loss is another consideration for limiting downside exposure.

For Example Buy 100 shares of BAC at 16 and at the same time buy Sep 2009 puts @ 16.00 Strike for 1 ( buying the right to sell at 16 dollars ) Your total cost of this share is now 17 dollors. and you are protected with this price for 37 days

Scenario 1 : If BAC reaches 18 dollars in one month, your puts premium value may be at .25 cents. If you would like to quit the game at this stage you will be getting 200 dollors profit on your share and 75 cents loss on your puts. In total your are in 125 dollar profit.

Scenario 2 :

If BAC is down by 4 dollars and reaches 12, you can do two things here, one is selling the stock at 12 and selling your puts at a premium of around 4 dollars ( approximate figure ) or Executing the right to sell your stock at 16. In this case your total loss is your premium amount only.

Example

For example:
BOT 100 XYZ @ $36.00
BOT 1 JAN 35 XYZ PUT @ $2.00
Commissions: $.50

Please note that each and all of the above variables (stock price, put strike price, put option expiration date, put price [intrinsic value and/or extrinsic value or both]), commissions, and many more not shown here, are usually carefully considered before applying this strategy.

From the above example, a breakeven calculation could look like this: Breakeven = Cost basis plus cost of put plus commissions ($36.00 + $2.00 + $.50 = $38.50). This means that the share price must climb $2.50 before a profit can be realized on the strategy employed. The values used in this example are for demonstration purposes only and may not represent typical pricing.

If one continues to buy puts to hedge the position (aka buying/writing protective puts), one can, over time, effectively increase the costs beyond the probable upward price movement of the the stock. In effect, one can over-spend the concept until a likely recovery is infinitesimal. In that sense, the married put combined with consecutive subsequent protective puts boasts theoretically unlimited loss potential.

The married put strategy is generally available to all market participants. Consult with your broker for specific availabilities. For instance, if options are not available on shares you own or intend to buy, the married put strategy cannot be employed.

References

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