Married Put Critics: Aren’t Long Calls Better & More Profitable?
Critics Question: On March 21st, Google was at $397. I bought 1000 of the JAN 2010 350 Calls for $73. Today it’s worth over $240,000…The same $73,000 would have bought me 200 shares of Google and the 420 strike put option was a ton of money. But today the put is worthless and would it not just take away alot of profits??
RadioActiveTrading Staff Answer: Although Married Puts and Long Calls seem to have the same risk/reward profile, Long Call positions can be over traded and take on too much risk. Yes, the GOOG position worked out, but we never know the future. Here is a different example of how the Married Put would have been a better trade compared to a Long Call position:
On Sept. 9th STEC was at $40.95 and had 2 alternative cases:
Buy FEB 2010 45 Calls @ $6.30.
OR
Buy a Married Put:
| Buy to open STEC | $40.95 | |
| Buy to open FEB 2010 45 PUT | $10.50 | |
| Amount invested | $50.95 | |
| Guaranteed exit price | $45.00 | |
| At Risk Amount | $5.95 | or 11.7% |
Today the STEC is about $12 (down 71%) and the call is worth ZERO for a 100% loss.
The married put is worth $45.00 with the same max. loss of 11.7%. However, we wrote calls and made several points over the last couple months, which limited our losses to under 10% with the stock down 71%. Yes, you may have been able to sell short calls against your Long Call to also reduce the risk for that trade, but if you sold calls below the $45 strike price, you would have had to put up more margin to cover the spread.
So…Today the call is worthless, but the married put has less than a 10% loss.
The Long Call investor went bankrupt with nothing left to invest, but the married put investors next investment was a married put in GOOG and did very well.
This example assumes that the Long Call investor would take their full trading capital, let’s say $10,000, and purchased 16 Long Calls (total investment of $10,080) and the Married Put Investor would have purchased 200 shares of stock and 2 put options (About $10,200).
Pundits and gurus keep saying:
Long Stock + Long Put = Long Call.
It isn’t so.
Actually: Long Stock + Long Put = Long Call + CASH.
The missing ingredient that makes those two positions equivalent… at “parity”… is cash on deposit in an interest bearing account. That’s the mathematical truth (check “Black-Scholes”). So there is no advantage to trading a call unless that call is only a small portion of your tradeable capital, and the rest is tied up in an interest bearing instrument. (in The Blueprint, we discuss how to use the proper position sizing in Long Call positions to have a true parity to the Married Put position.)
In fairness to your question, YES, if we knew that a stock was going to double over the next 90 days, would we put CALLs rather than trade a married put….uuhh…YES, of course we would!!
Problem is, you never “KNOW” that a stock will do that.
Does trading a married put limit some of the profits, compared to just buying long stock or buying long calls?…uuhh…YES, of course it does. You can’t get an insurance policy for free. Anytime you limit risk, then you are also limiting some of your reward.
December 20th, 2009 at 1:04 pm
At first I thought this was going to be an unfair comparison but all of the correct information appears to be there. However it is misleading by using the over-traded example. One doesn’t have to over-trade. If the individual trades the parity contract (e.g. 2 long calls as opposed to 2 married puts) and reserves the cash, I believe the two are identical. Which i believe is what was stated correctly as
“Actually: Long Stock + Long Put = Long Call + CASH”
If indeed they are equivalent, there is one advantage of the Long Call + Cash position in that I don’t have to pay the extra comissions for the Long Call. I believe this would be a much better comparison. I apologize if I’m missing something here as I’ve just started the Blue print course but am fairly familiar with the option basics and greeks.
December 20th, 2009 at 1:07 pm
whoops! correction to previous comment:
The sentence “…I don’t have to pay the extra comissions for the long Call.”
Should be
“…I don’t have to pay the extra comissions for the stock purchase.”
Fingers got out of sync with mind
Sorry
December 21st, 2009 at 10:33 am
It seems to me if you write a covered call say 200shares and by a put for four hundred shares. You would be covered plus? If the stock is high quality a put would be minimal charge? Right or Wrong?
December 21st, 2009 at 11:51 am
Answer to Mike:
True… one does not HAVE to over-trade… but remember we are dealing with people here, and human error or weakness can enter into the picture.
The primary reason (I’ll list several others below) that I teach using a married put is that it FORCES position size. Yes, you can trade a long call AND make a deposit, AND not touch it for any reason during the duration of the trade, or open any other long calls… but who does that? The married put forces one not to overcommit his/her capital.
As to the commissions, I place my orders with OptionsXpress to buy stock and a put, and end up paying only one commission for the entire position.
Here are a few other good reasons that I favor married puts over long calls:
1) Adjustments are easy. If I were to sell a near term call against a long call, or sell a bear call spread against my long call, or do any number of my co-called “Income Methods” (adjustments at a net credit), I’ll need to pony up margin anyway. If I own 100 shares of stock for each short call however, I am always covered so I don’t ever have to think about margin requirements.
2) Trade clearance is relaxed. This is a common concern: can I do this trade in an IRA? Many adjustments to a long call CANNOT be done at most brokers without a higher trade clearance. Paradoxically, these adjustments would be safer, done correctly, than a covered call trade.
Take the example of Income Method #6: Selling a Bear Call Spread. WHen you own 100 shares of XYZ, and have the clearance to buy long puts… well, you have the clearance to buy long calls also.
I recently showed a Blueprint owner how they might trade a bear call spread in their Schwab IRA: She owned 300 shares of RIMM and could buy to open Jan $75s, while selling to open Jan $70s. The short calls are treated as a covered call because she owns the stock.
Later, to expand her trading clearance she may truthfully state on an application that she has experience trading spreads, even though Schwab did not treat it that way. It was a covered call, plus a long call! All in a put-protected stock.
3) Price Break. Depending on a stock’s put/call ratio, as well as other factors… It may be significantly better to buy a stock and put than to buy a long call.
The reason is that part of the call’s pricing is the consideration that one could alternatively buy stock OR a long call and put the rest into an interest bearing account. Buying the stock and put may result in a price break that equates to having been paid the interest up front.
I show this rather plainly in a video on youtube at http://www.youtube.com/watch?v=D0tQk-QIBRE
and it pretty much floors everyone that wants to say that a long call and a married put have IDENTICAL risk.
Now, I know that to get the money back out we have to sell the stock and put… or do we? Near term calls can be shorted against the arrangement, capturing premium that’s inflated over what a near term put and stock would yield.
Clear as mud? Naw, check the math as well as the theory. You’ll find that there are opportunities to get an edge.
Not that I’m talking about an arbitrage opportunity… one COULD use the example in the video (ESRX married put premium of $7.35 and long call premium of $8.30) for arbitrage, but find out in the end that they had only solved Black-Scholes for the risk free interest rate.
Yes, I use a married put for an edge on the buy side, but it’s still a directional trade. And one that I CAN’T enter into too many contracts if I don’t have the capital. Which brings us back to the primary reason I prefer married puts over long calls: FORCED position sizing.
L.S.:
No, the trade you have described becomes a synthetic straddle, with short calls. WAY different risk picture.
Happy Trading to you both!
Kurt
December 31st, 2009 at 8:28 pm
can i do a covered call trade and sell an in the money call.is there anything wrong or illegal about this?
January 4th, 2010 at 11:32 am
No, there isn’t anything wrong or illegal about selling an ITM call. You just need to realize that you are taking on an obligation to deliver the stock at the strike price on or before the expiration date.
January 16th, 2010 at 2:54 pm
Kurt,
Your logic makes sense, but I just don’t see the numbers play out. But I’m still a beginner at options, so maybe you can clarify it. For example, if I use optionsXpress’ Trade & Probability Calculator for GE:
Married Put: buy 1000 shares + buy 10 x Aug 30 Put
vs
Long Call: buy 17 x Aug 30 Call
with the same maximum loss in $ (that’s why buying 17 calls), it appears as if I could make twice as much with the long calls:
(I hope this formats OK in the blog
GE Aug 20
1000 shares Married Put 17 long calls
Price Profit / Loss Price Profit / Loss
12.33 ($390.00) 12.33 ($391.00)
14.76 ($390.38) 14.76 ($391.00)
17.32 ($389.79) 17.32 ($391.00)
19.88 ($390.19) 19.88 ($391.00)
20 ($390.00) 20 ($391.00)
20.39 $0.00 20.23 $0.00
22.44 $2,050.40 22.44 $3,757.00
25 $4,610.00 25 $8,109.00
Thanks
Dennis
January 16th, 2010 at 2:57 pm
hoping this lines up so it’s easier to read
_________1000_shares_Married_Put___17_long_calls
_________Price_____Profit_/_Loss___Price_____Profit_/_Loss
____________12.33_______($390.00)_____12.33________($391.00)
____________14.76_______($390.38)_____14.76________($391.00)
____________17.32_______($389.79)_____17.32________($391.00)
____________19.88_______($390.19)_____19.88________($391.00)
_______________20_______($390.00)________20________($391.00)
____________20.39___________$0.00_____20.23____________$0.00
____________22.44_______$2,050.40_____22.44________$3,757.00
_______________25_______$4,610.00________25________$8,109.00