Sell the Legs of a Married Put vs. Exercising the Put?

Q: When you close a position, do you sell the individual legs? i.e. Sell to close the stock at the lower price and then you sell to close the (protective/married) put instead of exercising the put at the higher strike price?

A: If you are looking to liquidate a Married Put position and the put still has a few months to expiration, it will always be better to Sell to Close the Stock and Sell to Close the Put, rather than simply exercising the Put option.

Why? An Option price consists of two parts: Intrinsic Value (how far In-the-Money is the option) and Time Value (the premium priced in to the option for the days remaining to expiration).

The option should always be priced at least at the Intrinsic Value. For example, if a stock is trading at $35.00 per share, the $40 strike put for that stock must be priced at least at $5.00. If the option was priced below $5.00, there would be an unfair advantage in the market.

Now, if the option expires next month, the $40 strike put may only be priced at $5.50 or so. $5.00 of that price is the intrinsic value, $0.50 is the time value. A $40 strike option on the same stock that expires 6 months out in time may be priced at $6.50 or so: Again, $5.00 of intrinsic value and $1.50 of time value.

Let’s say that I am in a Married Put position with the 6 month out option. If I exercise the put option, I only receive $40 into my account. However, if I sell to close the stock and sell to close the put option, I would receive $41.50 in my account ($35.00 for the stock, $6.50 for the put option).

If I am holding a position where the put expires in a couple days, most if not all of the time value will have decayed out of the option. If it is Thursday before an expiration date, and my put expires this month, my $40 strike put on a stock trading at $35.00 per share may only be valued at $5.10 or $5.05. In this case, I may simply exercise the put as I would only receive $0.05 or $0.10 more for liquidating the position.

About Mike

Michael Chupka is the Director of Education for Power Financial Group Inc., publisher of PowerOptions, a patented online suite of options investment research and analysis tools. He has co-authored two books, the first on Naked Put strategies and the second on the protective Married Put and Collar strategies.