Why would I buy stock with a married put when I could buy a call option?

This is an excellent question. Many investors are lured to options investing because of the concept of leverage.  You can take advantage of a bullish stock by simply buying a long call and putting up 1/10th of the cost to own the stock, or you can enter into a credit or debit spread and have a low-cost and low risk exposure in the position.

However, leverage works both ways, and most investors over time fall prey to the Lie of Leverage.

One of the 3 Core Principles of RadioActive trades is F.I.S.T – Forcing an Ideal Sized Trade.  The starting point for every RadioActive Trade, the RadioActive Married Put setup, guarantees that I am only risking a small percentage of my capital invested into each trade and at the same time a small portion of my portfolio.

The leveraged positions mentioned above allow investors to use less capital, but this usually comes with the duality of over trading and over exposure.

Long Calls:

We do not argue that a long call position does not have a similar risk-reward profile to a married put position – but they are NOT parity trades.

Let’s say you and I have the same account size of roughly $100,000, and both of us have about $15,000 in free capital.  I might enter a Married Put trade as:

Buy 300 shares of DAL @    $38.50
Buy 3 MAR 40 strike puts @ $ 4.50
Total Invested =           $43.00 ($12,900)
Guaranteed Exit =          $40.00 ($12,000)
Total At Risk =            $ 3.00, or 6.9% ($900.00 total at risk).

The $900.00 total at risk represents only about 7% of our total investment, and only 0.9% of our total portfolio value.  We are forced into an ideal sized trade that:

Has a single digit risk
Has less than 1% at risk of our total portfolio
Has an infinite upside profit potential

Now, you may look to purchase the MAR 40 call to apply leverage:

DAL MAR 40 Call @ $3.30

With your $15,000 of free capital you could purchase up to 45 contracts.  You would now have $14,850 invested in the position, unlimited upside profit potential, but about 15% of your portfolio at risk on one position…

Okay, that was an exaggeration.  I know you would not invest the full 15K into one long call position, but let’s be honest about the nature of the long call investor.  You see that I opened 300 shares and 3 puts, and you decide to buy 3 call contracts:

3 contracts of DAL MAR 40 call @ $3.30 ($990)
Total at risk = $990.00, or about 1% of your portfolio.

But…what do you do with the remaining $14,000 in your account?  Do you leave it aside?  No, most likely you would buy 5 calls of XYZ, 6 calls of ABC and 10 calls of stock 123.

We are now no longer at parity.  Your exposure to the market is much higher, where I am still risking only 0.9% of my total portfolio from the $15,000 of free capital in my account.

Spread Trades:

During the webinar we showcased the Trade Simulator Tool.  A common risk-reward ratio of a high probability, leveraged spread trade is 10:1 or about 9:1.  I may collect $0.50 on a 5 point spread that has an 80% probability of expiring worthless, or perhaps a $1.00 credit on a 10 point spread.

If I placed 10 trades in a given month with my $15,000 free capital and:

8 trades expire worthless (keep the $4.00 in premium)
1 trade is closed for break even (close short option for $0.50)
1 trade goes against me and takes full loss (loss of -$4.50)

I was essentially right 80% of the time (or closer to 85% of the time if you consider the 1 break even trade as no gain / no loss) and made no money.  Although these positions are tempting due to the low margin commitment and high potential % return (both positions above would have a potential 11.1% return on margin), the Structure of these trades makes it difficult to profit long-term.  One max. loss can wipe out 10 previous trades.

In addition to that, the gain on the spread trades is capped, so I do not take advantage of large moves that might occur in my desired direction.