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.
Click to Enlarge
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 completely 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
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
I’m trying to understand ……
If an $81 stock goes to $100, that’s ~18% return. But RMP only returns 3.6%? And, if the stock went down RMP looses ~11%.
How about buying the stock, putting in a 15% stop loss order, and hoping for an 18% (vs 3.6%) upside return? (an alternative to the stop loss would be buying a cheap OTM put — and you’d still have 18% potential upside!) If the stock is any good at all, it would have to break several resistance levels to drop 15% and get stopped out. I know that’s pretty simple thinking, but it seems like a lot better risk/reward ratio.
I apologize in advance if I didn’t correctly understand the example provided.
Thanks – Dave
HI Dave,
Well, the intent of the article was to define differences between a long call and married put, hence the title 😉 For this reason I deliberately left out the adjustments and management techniques that make RT famous. Also, I would not put together an RPM that risks more than 10%, so the married put example I did in this article is not really according to The Blueprint.
Again, the point of the article is to illustrate that married puts and long calls are NOT identical ways to allocate one’s trading capital unless one does NOTHING else with the rest of the capital except deposit it for safekeeping.
Perhaps I’ll post an example that includes a less dramatic difference; I went deep in the money, very far out in time to illustrate the difference that interest rates make in the pricing of married puts vs. long calls. Thanks for your comment!
[…] identical. I finally couldn’t take it. I was reading this article by Kurt Frankenburg on Long Calls vs. Married Puts and decided I had to say something. Investors and traders should know these two positions are […]
[…] identical. I finally couldn’t take it. I was reading this article by Kurt Frankenburg on Long Calls vs. Married Puts and decided I had to say something. Investors and traders should know these two positions are […]
I liked this much more than previous articles you have written on the topic. Well done.
[…] identical. I finally couldn’t take it. I was reading this article by Kurt Frankenberg on Long Calls vs. Married Puts and decided I had to say something. Investors and traders should know these two positions are […]
I am now on the side of the long call side of this equation, with in the money investing, though not necessarily deep in the money. The $1 unit difference between -1 and -2 strike prices on the call side of the option chain matters little to me from what I am seeing so far, with it all still based on intrinsic value, so why not go 1 unit below strike and invest less capital in the long option position. From my securities I am looking at so far on the option chains, I get the full benefit, the exposure to runups in share price based on cycles such as quarterly dividends without risking anywhere near the capital. I can still liquidate the call with a Sell to Close order, the only downside being higher commissions than a straight long investment. This gives me more alternatives for investing my capital as a lot of my capital is not tied up in an equity position, and I get the full benefits of price appreciation. In other words, minimum downside risk but unlimited upside in the same scenarios. Extrinsic time value really only has value for covered calls or if the strike price is crossed before expiration where it will shoot up with intrinsic value. And if I divest from long equity positions and rely on selected call options long, I do not need to worry about covered calls since I do not have long equity positions. Crossing into intrinsic value doesn’t happen that often with my securities, and I like to project or forecast when I think there may be a cyclical runup in share prices for market forces and capitalize, such as quarterly dividends. And once more, I do not have credit risk because I have not taken an equity position. I can lose my option position, but I can not lose an equity position with credit risk for the company involved.
I can also go long on puts if I think we’re in a market downtrend, which is not as sexy to talk about but that cycle happens as well.
I almost will not see any scenario where I will short anything going forward, only buying puts as appropriate with minimal cash out. I get all the benefits of price fluctuation and potential gain and can spread my investment with available resources to other sectors, other industries where other gains could be possible. If things go south, the loss is contained.
I wish I saw the light of this a while ago, but I have seen it now. I have become an options trader 100%, and will not go long or short on equity again unless in the most unusual circumstances. I don’t need the dividend capture as well as share prices always go ex-dividend and the options follow suit, so the price effect of the dividend will be there to work with with the right call options. The higher commission costs frankly are the only downside effect, now that I fully understand what’s at play here.
Nice post. What concerns me are only two things: money management and trading clearance.
Money management is ‘built-in’ when you trade using equity PLUS a put option instead of a long call. The position size, or how much of your account that you can possibly LOSE as a percent is necessarily limited by the RadioActive Trading setup of stock plus a put option, where it’s easy to get yourself into trouble by doing straight options. That is, unless you have an enormous amount of capital on deposit in an interest-bearing account for every call contract you buy.
The second concern, trading clearance, applies if you are looking to adjust positions as I do to further contain, or even ELIMINATE risk in a position while leaving the upside open in a directional trade.
Some brokers will not allow you to sell a ratio call spread or bear call spread against a long call, but they will allow you to do the same against long stock in your account. Go figure. But it’s how the industry works.
SO! While it is possible to achieve some of the same aims with options only, it can be difficult. Especially in your case where you invest in IN the money calls, which just may be more leverage than you than you want unless you are a fanatic about position sizing. It’s important to remember that leverage can be used AGAINST you as well. For my part, I will continue to do those plays that force me not to get over-leveraged.
Best wishes to you Bill, and Happy Trading!
Kurt
Hi Kurt
I have been reading all your post and blogs and it has given me a safe platform to enter share trading again.
Like you I did trade spreads, long calls etc and lost a lot of money. When years ago I got assigned and lost a lot of my capital and promised myself never again.
Well here I am facing my demons again. This time with a margin loan and hope to stick to a plan. Your plan that is…..
I must say I am going to use your share/option trading stratergies in Australian market which is a much smaller market and we don’t have the tools and market volumes to trade with.
Wish me luck and hope to keep reading your blogs
Thanks
Tony A
Are these American-style or European-style options? Because if they’re European-style, the difference sounds like the difference between a forward contract and the stock itself (except maybe in terms of margin requirements); but if they’re American-style, I’m pretty sure it’s an arbitrage.