Aren’t Protective Puts / Married Puts EXPENSIVE?

Ah, just reveling in the morning after the FORT – Foundations Of RadioActive Trading Seminar. Here’s a question that came up, and that merits a good answer:

“Aren’t protective puts EXPENSIVE?”

Well… yes and no. I mean, they do cost money. The question should be phrased more like this: “Are protective puts WORTH what they COST?”

Better question, I think. Because guess what – the benefits FAR outweigh the costs. Plus, the put option may actually become a source of income…

IN the meantime, consider coming to any of our twice weekly Webinars. We’ll show three ways that the put can actually be a source of income in a married put trade.

The Blueprint contains ten income methods for taking money out of a married put (protective put) trade… five of which DEPEND on having a put in place already. But even without going into the fact that you can take income from married put trades in unique ways that manipulate the put option, let’s consider just the merits of trading with protection.

Everybody knows this about insurance and lawyers: better to have them and not need them, than to need them and not have them!

No reasonable person reading this post would invest in a piece of real estate that wasn’t insured. No bank would loan on a house or car that wasn’t insured. No business owner in his right mind would conduct business without at least liability insurance. So… what’s the big fuss about using puts to protect stock? I wouldn’t even THINK about trading without them.

Consider the two situations below. They are both true stories. One shows a losing stock with a put added and how it saved my bacon… and one shows a winning stock with a put added, and whether or not that was wise.

DRIV. I get into Digital River at $38.53. At the same time, I pick up an insurance policy… an in-the-money, Jan 2010 $45 protective put. What’s my expense? $9.20. “Wow”, you night be saying. “That’s a LOT.”

Is it? Hmmm…

October 12, 2009: DRIV GAPS down from $40.42 to $25.12 overnight… keeps heading down to a low of $23.82. It still has not recovered as of this writing in late February; DRIV is in the mid-twenties. Cost of trading this issue WITHOUT a protective put: $38.53 – $25.00 = $13.53 per share. That’s an overnight, over 35% gap.

Let’s compare that with the cost of the Jan 2010 $45 protective put. YES, I spent $9.20 for it… but I was always guaranteed to get most of that back. It’s like money in the bank. Look here:

DRIV stock per share $38.53
Cost of protective put +$ 9.20
Total Investment $47.73
Guaranteed Exit Price -$45.00
Total Amount AT RISK $ 2.73

See that? While it APPEARS as though I’ve SPENT $9.20 for the protective put, in truth I’ve only parked it for a bit. Most of thst value of that put is stored, intrinsic value that I’m guaranteed to get back.

And I did. SO, while some folks were licking their wounds, wondering where their $13.53 (35%) a share went, I was okay losing $2.73 (5.7%) and going my way looking for a winner.

Let’s look at this in terms of value: $13.53 loss vs a $2.73 loss is a $10.80 difference. Do we still think puts are expensive?

😉

Well, maybe that’s not fair. Maybe you were thinking more along the lines of, “Hey, I usually pick winners. SO using a protective put would needlessly cut into my profits!”

Well, okay. Since you have a crystal ball, I guess you never need a protective put. But! Let me tell you about this one anyway:

CREE I got into CREE at $51.73 a share and simultaneously picked up a June 2010 $60 put for 11.60. Let’s use the “five lines” RadioActive Profit Machine setup again:

CREE stock per share $51.73
Cost of protective put +$11.60
Total Investment $63.33
Guaranteed Exit Price -$60.00
Total Amount AT RISK $ 3.33

SO… On January 19, we’re expecting an earnings announcement just after the bell. Brigantine Advisors CUTS its rating of CREE from Hold to Sell during the day. I decide to hold anyway, having less than a thousand bucks (I bought 300 shares and 3 puts) AT RISK.

Know what? One of my clients had bought CREE earlier and got puts at a better cost basis. He was going into this earnings announcement BULLETPROOF… meaning that the combined cost of his CREE shares and his protective, $60 puts was LESS than $60. He couldn’t lose!

SO the announcement comes out and it’s GOOD. Next day, CREE shares shoot up to $63.95. It’s been going up since. Let’s look at the collective position today:

CREE stock per share $65.40
Value of protective put +$ 3.80 (bid)
Total Value $69.20
Original Investment -$63.33
Total Profit if sold now $ 5.87

Wow, a $5.87 per share gain instead of a $3.33 loss. There’s a skewed risk/reward picture, the only kind I like to trade. Now, sure… I know that if we didn’t have the put in place, the profit would have been bigger…

…but who has the intestinal fortitude to hold CREE through the earnings announcement… with an analyst downgrade during the trading day before said announcement… especially if he played DRIV recently and it dropped 35% overnight?

I’ll tell you who… I would. So would my client that called after the announcement and said, “Thank you… RadioActive Trading has changed my LIFE!” This because he was able have NO WORRIES after the bell, being long on a volatile stock with so much buzz on both sides. Up til recently holding positions overnight was stressful, but not any more. He was BULLETPROOF.

Actually, because of the “Income Methods”… adjustments that I’ve made to the position at a credit… my CREE position is bulletproof as well. That means I still have the upside way open, but no risk at all left in the trade. It’s going to make for a very peaceful night of sleep for me before CREE’s next earnings announcement in April.

Only my Fission‘ Members get to see the details of how I bulletproofed CREE using the ten Income Methods of The Blueprint… but you can check out a “virtual” CREE position by going to the Plain Vanilla Portfolio on http://www.radioactivetrading.com.

Okay, gang, fire away! Tell me what you think about trading stock with an insurance policy… the “married put” or “protective put” position.

About Kurt Frankenberg

Kurt Frankenberg is an author and speaker about entrepreneurship, martial arts, and trading the stock and options markets. One of several "Biznesses" he founded as a teen, The Freedom School of Martial Arts, has been in continuous operation since 1986. Kurt lives in Colorado Springs with his wife Sabrina, German Shepherd Jovi, and his ninja cat Tabi.