Long Calls vs. Married Puts

One argument I get, time and again about entering a trade with a married put instead of a long call is this:

“A long call is IDENTICAL to a married put!”

Not true. Also,

“Buying a call is THE SAME THING as buying a married put, but better!”

Huh? Are you as confused as me? How can anything be identical to… but BETTER than… anything else.

Wow.

Well, let me set the record straight. There are three logical, mathematically sound reasons that I trade married puts instead of long calls.

FIRST UP: Parity. “Parity” is the word my critics drag out to imply that I’m wrong about the married put/ long call controversy. In fact, there is no room for controversy because anyone that can DO math can’t argue with this fact:

A married put does not equal a long call.

Don’t believe it? Okay, say you place an order with your broker to buy 100 shares of CTSH at $81.40, plus a Jan 2013 $85 put option at $15. How much have you spent? That’s $96.40 in my book… or $9640.

Now, instead of filling your order for a married put, the broker takes your $9640 and instead gives you a Jan 2013 $85 call option, currently asking $12.60.

 

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Wouldja be happy? Oh, why not? Could it be because the long call and married put are not IDENTICAL? Hmm, that’s right… if they WERE “identical” you would have $9640 worth of assets to liquidate, not $1260. I don’t think anyone would be happy with spending $9640 and getting a long call worth only $1260.

Here’s the dealio, folks: to invoke the mighty “parity” word… which means “equal in all respects except form”… we need to do something with the rest of that capital. Part of the Black-Scholes pricing model is interest. The pricing of a long call ASSUMES that you have the capital on hand to buy the stock… but you DON’T… and instead put that capital into an interest bearing instrument, say 90 day T-Bills.

NEXT: PERCENT RETURN/RISKED IS DIFFERENT!

“Oh, but that’s just my point, Kurt.” My critics might say at this juncture. “A long call costs so much less than a married put, so you can do the long call trades with much less capital.”

Yes, you CAN trade with less capital, but that doesn’t necessarily mean that you SHOULD, does it?

Say the long call buyer in this example has $10K to trade, and I have $10K. Can we both participate in a trade with the $85 strike on CTSH? Why sure… $1260 is well within the long caller’s capability to buy a single 2013 $85 call. Me, on the other hand, I like to have enough capital to actually buy the stock. So with my $10K I can only get 100 shares plus one 2013 $85 put.

Let’s examine winning trades first. Say at the end of this position CTSH is at exactly $100.

The $85 long call position is worth $1500. The long caller (wisely) bought only one contract today at $1260, leaving $8740 in his account. He adds the $1500 to the unspent $8740 to show a $10240 balance… a respectable, 2.4% return on $10K.

The married put user (me) used $9640 of his capital to buy stock and a 2013 $85 put. That leaves $360 in the account. At the end when CTSH is valued at $100, that’s $10K plus the $360, a $10360 balance or 3.6% return on $10K.

“But..! So the married putter got a higher return, so what? Because the long caller used less capital per contract, he could have gotten into as many as eight trades instead of just one, and ‘octupled’ his return! That’s 19.2% return, not 2.4%!”

Hmmm… sure you wanna go that route? Okay, how about if those trades were losers?

Say CTSH goes way down in value instead of up. The long call buyer, if he uses only one contract, loses his entire investment of $1260 and is left with $8740. That’s a 12.6% loss. If he DID get into eight contracts, he would be ┬ácompletely bankrupted.

On the other hand, the married put buyer sells his stock for $8500 (because he holds a long, $85 put), adds that to his $360 unused capital, and has $8860 left over… an 11.4% loss.

Wow. Any way you cut it, the long call loses more. If we compare apples with apples… one long call contract vs. one hundred shares plus a one put the same strike… we end up losing different dollar amounts. If we make money, it’s different amounts as well, BUT..! The long callers will always bring up the point that they can invest more contracts. Okay then, for this example…

Married Put, one contract: 3.6% on wins, -11.4% on losses

Long call, one contract: 2.4% on wins, -12.6% on losses
Long call, TWO contracts: 4.8% on wins, -25.2% on losses
Long Call, FOUR contracts: 9.6% on wins, -50.4% on losses

…should I stop here and point out that for every 50% loss, one must DOUBLE (100%) his return on the next plays to get back to the starting point? The more leveraged the long caller becomes, the harder it is for him EVER to get back to square one if he suffers a single loss.

FINAL POINT: CLEARANCE FOR ADJUSTMENTS

We’ve seen that the married put and long call are NOT parity… married put and long call PLUS unused capital are parity. We’ve also seen that because of the impact that interest rates have in the pricing of “parity” options, the long call may lose more and gain less… than the married put… in losing and winning examples.

NOW we’ll explore the final reason why I use married puts instead of long calls in all of my starting positions. I say “starting position” because after a certain set of circumstances happens I may be able to convert a winning RPM (RadioActive Profit Machine… what I call a stock with a far-out, ITM put) into an options-only position that risks zero or less than zero.

The final reason married puts are superior to long calls is that many folks that CAN’T get cleared to run a calendar call, or sell a ratio call spread… CAN sell covered calls against stock that they own, even when it’s protected by a put.

A ratio call spread can be done by buying one call option and selling TWO call options… by a trader that is only cleared to do covered calls… provided that that trader has 200 shares of stock to deliver.

A lot of the cool adjustments simply cannot be done in the stodgy institutions without a heavy duty trading clearance, due to years of options trading and piles of discretionary capital. Ironically, these very plays are some of the safest one could do if they are simply done in the context of stock ownership.

THEREFORE, besides the fact that a married put often outperforms a long call in terms of safety as well as returns… I use the married put setup because that long stock makes it simpler to do the advanced adjustment strategies of The Blueprint.

I’m happy to set this forth again in opposition to my critics’ silly claims. One day, the more honest intellectuals of that group will have to concede these points. A long call is in no way equivalent to a married put.

Happy Trading,

Kurt

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.