I just had a fella post a question/comment to my blog:
“If you buy a put for insurance, doesn’t the put take away from your gains if the underlying stock goes up?”
Short Answer: Yeah.
FURTHER Answer: Your point being? Cutting losses short almost makes my whole trading plan take care of ITSELF.
Heh… well, without trying to sound TOO smug, here’s the deal: when you have very small losses, you don’t have as much ground to make up either. So a more modest return is okay.
Consider this: say you were trading long stock (no margin, no leverage from a long call… just stock) within the last three months, you might have seen gains of 20, 30% or more.
But you might also have suffered losses in the last few sessions of 20-30% as well. Hope I’m not striking a nerve… but if I am, that’s all the more reason to pay attention to this particular blog post. Because if you truly GET the principle of expectancy and skewed risk/reward… it can make you rich.
Let’s use the example provided by the market’s last two weeks or so. Take the middle of the road: 25% losses. A 25% loss needs a 33.33% gain just to recoup losses. With 25% loss and 33.33% gain, you are even-Steven… same place as you began.
On the other hand, say your married put positions only gained 12% on the way up… like my 1st ALTR play (described elsewhere on this blog). While the stock went from $27.35 to $33.10 during my holding period of seven weeks… a 17.3% gain…. my married put play only picked up 12%. Boo hoo, Kevin was right… my Married Put play limited my gain. 12% versus 17.3% means not as high performance as straight stock. Shucks.
But then… my second Married Put play with ALTR lost 5.6% during a period of time that the stock itself lost 21.8%. It’s down even MORE now but my max loss would still be locked in at 5.6% if I got out today.
I just closed that one last week. Now you tell me… had I been playing stock only during both of those time-frames, it would have been 17.3% on the winning play, 21.8% on the loser. Assuming similar position sizes, am I ahead or behind? Door number two, sorry… I woulda lost with ALTR overall.
But as it stands with my Married Put setups… yes, I “only” took 12% on the way up, and lost 5.6% on the way down. Again… the position sizes were almost the same. You guessed right: in the SAME market with the SAME stocks, entered and exited at the SAME time… The Married Put plays leave me ahead.
That’s only being right 50% of the time. Think about it… would YOU play a coin toss game in which winners paid 12%, and losers took 5.6%? Knowing what you do about probability and statistics, would you want to play this game from sunup to sundown? Heh… I sure would.
Remember when I said that if you truly GET this principle of skewed risk and reward, it could make you rich? Now’s the time to go back up to the top of this article and invest the two or three minutes it took you to get to this line… once more. 😎
Hey, sound off below, folks… would you like for me to show the charts, entries, setups for both the winning and the losing trades on ALTR? Again, if I had traded a covered call or long stock it would be a net loss. But since I was playing a Married Put on both, we have a net win. Who else would like to see that graphically?
Happy Trading,
Kurt
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
Kurt,
I bought STZ a few months back for 21.35 and then bought a Jan ’12 22.50 protective put for 2.50 giving me a max loss of 5.66% (thank you very much). STZ is now at 16.63 (a 22% loss). If I wanted to exercise that put and sell the stock for 22.50, don’t I have to sell the put for its current price of 3.90, costing me an additional 1.40, then sell the stock thereby giving me a larger dollar loss on the trade? I haven’t made any adjustments to the trade yet, just wondering if that’s the procedure. Thanks for the great info and insight into this strategy. definitely worth its weight in gold in this market.
Rob G
I’m glad you asked, Rob!
So many folks write in with an objection like this. It’s from not fully understanding the rights conferred by owning a put. Check the comment of D.S. below (NOT picking on you, D.S., rather illustrating that a LOT of folks just don’t understand puts), who said that if my stock was at $49 then the $55 put I had purchased could expire worthless.
No. Exercise is exercise. You may EXERCISE your RIGHT to “put” the stock to the put seller… that’s how it works.
With STZ this deep in the money, the options market maker has gone nutty with his bid-ask spread: with STZ trading at $16.52 I see the bid price for the Jan 12 $22.50 option at $5.10. That totals only $21.62… but that options gives you the RIGHT to sell STZ at $22.50, correct? You don’t have to sell the put and stock separately, you may exercise. This is North America, remember? Only European style options cannot be exercised before the expiration date.
So here’s the deal. You may simply exercise your option. Call your broker if you have not done this before and have him (her) walk you through the exact procedure for your brokerage house.
You have two other alternatives: you may hold for longer, even all the way til expiration, to see if STZ comes back. You may be barking up the wrong tree in this market, but you will incur no further risk by hanging one. The other alternative is that if you are bent on selling the option and the stock separately, use a LIMIT order to ensure that if it is filled, you get out for more than $22.50. It may be worth the dime or two that you bid.
Rob, THANKS for the kudos. I am glad that with a purchase price of $21.35 for a stock that you were bullish on… the market is handing out $16.52, a nearly five dollar loss. But not for you. You get to say, “no thanks.. I’d much rather have a $1.35 loss.” No one likes to lose money but in contrast to other bulls you will still have 95% of your capital to work with on the next trade. Bully for you!
Happy Trading,
Kurt
Yikes sorry I didn’t post here sooner everyone. Rob got a reply from me from support@radioactivetrading.com but I never posted here for everyone’s edification.
SOMEtimes, especially when the market is going batty, your put’s bid price will be unreasonably low. That doesn’t affect the fact that you have a legal and binding contract.
The market maker (penny pinching bastard) wants to pay as little as possible for that put if you cash it and the stock in separately. But ‘exercise’ is not the same as selling your stock and put separately. When you exercise your put you MUST get the $22.50 out of the net position.
Thus, you have paid $23.85 for your married put, you get $22.50 back. That’s a $1.35 loss, or 5.66% of your capital. If you had bought the stock only and had NOT picked up that put, your loss would stand at $21.35 – $16.63 = $4.72, or a 22.1% loss of your capital.
Good for you. Sorry you had to take a loss at all, but now you have more than 94% of your original capital left to catch a winner with, as opposed to less than 78% remaining.
Short answer: when the market maker is being unreasonable and your limit order to sell the stock and put together for more than the put’s strike price isn’t being picked up… then just exercise.
Happy Trading,
Kurt
Kurt,
I realized something in the recent down turn that I hadn’t experienced in using Radioactive for before. The trade woked out so great (at least for me) that I just put the same setup on AEP. I feels so “right” that I must be doing something wrong.
BTO AEP @ 35.48
BTO Jan 13, 45 put 9.90 8/17
Total Cost 45.38 ITM 19% at today price of 37.8
Put Coverage 45.00
At Risk .38
Annual 2012 Div -1.83
Nov 2011 Div -.46
Bullet Proof -1.91 or 4.20% before using any other mehods
Objective: LT dividend growth, hedging, and income from the other methods if presented.
I did this originally with AT&T. It was a great feeling to see the gain hold its value when things busted down last week. In uncertain times like these, a light hit in yield is a small cost for giving our economy time to work itself out.
Any thoughts?
Wow! I would love to have fills like that on a married put position with a dividend stock. Was this done with individual limit orders on the stock and put, or was this done with a limit order on the entire married put position?
(I replied to Chuck in a longer email from the RadioActive Education office)
Chuck, it may feel right, but it IS right! With an objective of “long term dividend growth, hedging, and income from other methods if presented…” This was a fantastic play. You have Bulletproofed your position and there is no hurry to apply the Income Methods since it is clear out to 2013 before your insurance policy runs out. Bully for you!
Happy Trading,
Kurt