Can’t I do Better than a Married Put if I Entered the Trade as…

Once again, the questions come in from investors being introduced to RadioActive Trading about trade entry.

We run comparisons every few months based on customer feedback and new trading ideas for limiting risk – and every few months we feel more confident that the Married Put structure used at RadioActive Trading is the best way to go.

I’ve had this particular question come up in a few recent webinars, as well as via email:

“…instead of buying immediately the combo “Stock + Protective put”, could we not sell a put OTM at let’s say a 0.3 delta for instance.

If the put is assigned at expiration, the initial credit received will paid a part of the protective put.

If the Put is not assigned we can start again the same process is expectations regarding the stock are still in place.”

What does this mean, exactly?

Every new RadioActive Trade we open is entered as buying stock and buying a far out in time, put option to control risk.

But as options traders we know that we can ‘Potentially get into a stock at a Discount’ by selling Naked Puts.

When we sell a put we enter an obligation to buy shares of stock, if the stock is trading below our sold put strike price at expiration. We receive a premium up front, and have the opportunity to buy shares of stock at a lower price.

Why pay for the stock up front when you can receive payment for the chance to buy stock later, at a cheaper price?

These are the correct questions to ask, and the same thing I asked when I was introduced to RadioActive Trading about 10 years ago. Here’s the rub: It does not work out as well as you would think because of the structure of the trade. Let’s take a look:

About 30 days ago, on June 12th, 2017, this trade for Alibaba (BABA) appeared in the RPM Reports on Fusion:

Buy to Open BABA at             $139.08

Buy to Open DEC 145 put at $14.50

Total Invested =                       $153.58

Guaranteed Exit = –                 $145.00

Maximum at Risk =                 $ 8.58, or 5.6%

Maximum Profit =                    Unlimited

Profit and Loss Chart of BABA RadioActive Trade with the numbers from 6/12/2017 taken on 7/13/2017

The position has a Bullish sentiment, with a positive upside delta, and carries a worst case scenario of only a 5.6% loss on investment (Only $858 at risk on an investment of $15,358).

The stock is trading at about $149.50, up +$10.42 since purchase, or 7.5%.

Of course, the put has lost value as well and is currently trading at $9.25. We paid $14.50 for the put, so we do have a loss of -$5.25 on the put. But gained $10.42 on the stock we own.

Right now we have an unrealized profit of $5.17 on the stock and put combination, or roughly 3.4% in 30 days. Note that the stock is still well below the ‘Break-Even’ of $153.58 – but we already have a profit.



But Couldn’t We Do Better Using Less Capital and Got Into the Stock at a Discount?

Well, sure…in a perfect world with the perfect outcome.  If I purchased the same DEC 145 put on June 12th, but sold an OTM put to get the stock at a cheaper price, I would have a lower capital requirement. I COULD get into the stock at a cheaper price – if the stock was trading just below the short put strike at expiration. But is the risk lower? Is the position better?

Here is the setup of a ‘Calendar Put spread’ that could have been opened on June 12th for BABA– the same time as the RadioActive Married Put:

6/12/2017: BABA trading at $139.08. Enter Calendar Put Spread

Sell OTM 21-JUL 135 put at      -$ 3.55

Buy DEC 145 put at                      $14.50

Total Net Debit =                          $10.95

Maximum Risk =                          $10.95, or 100% of what is invested

Max Return =                                $ 5.00, or 45.7% – if and only if BABA is trading right at $135 on 21-JULY

Okay, let’s break this down.

  • The Calendar Put spread requires only $10.95 per contract to enter, vs. $153.58 per share of the Married Put. I am definitely not saying this approach requires less capital to trade.
  • The Maximum Risk of the Calendar Put is the debit, or $10.95. This is $2.37 higher at risk than then Married Put at $8.58.
  • The % at risk? Hey, the Lie of Leverage works both ways. Sure, this leveraged spread has the potential to earn 45.7% of the investment…if and only if the stock is trading right at $135 on 21-JULY expiration. That’s a tough target point (which has already been vastly exceeded). But, you are taking a risk of 100% of what you invest. The Married Put only risks 5.6% in the worst case scenario. Not even close.

But, what else? The RadioActive Trade gives a positive delta to the upside. We have made a profit even though the stock has not reached the ‘Break-Even’ point of $153.58. When we open a RadioActive Trade it is because we have the Expectation that the stock will mvoe up 3-6% in the first 30 days…

The Calendar Put has a negative upside delta. It loses money of the stock moves up. Let’s take a look at the graph of this ‘Cheaper and Better’ way to enter an RadioActive Trade:

Profit and Loss Chart of BABA Calendar Put with the numbers from 6/12/2017 taken on 7/13/2017

Oops. This does not look good. With BABA around $149.50, we are entering the loss zone to the upside. As the stock rises, we make less and start to lose money with this approach, where the Married Put is gaining more and more.

Sure, you collected $3.55 up front for selling the OTM put. But, that is all you can make if the stock moves up in price. Meanwhile, the DEC put (same as used in the RadioActive Trade) has lost -$5.25.

The current liquidation value of the Calendar Put spread is -$9.15 (Sell to close DEC put at -$9.25, Buy to Close JUL put at $0.10. But the Debit to enter the trade was $10.95, so we are at a loss of -$1.80, or

-16.4% of what we invested (3X the Maximum risk on the Married Put – which again is at a profit).

Am I Saying That You Should Never Use a Short Put / Calendar Put Spread?

Well, kind of, if you truly want to control risk (which is the only thing we can control in the market).

Simply selling a Put, called a Naked Put or Cash Secured Put takes on a lot of downside risk. If the stock gaps down you can take large losses to the downside, which will wipe out many previous gains.

The Diagonal Calendar Put spread can be a useful strategy – if you are neutral to bearish on a stock. That is the key. When I open a RadioActive Trade I am selecting the stock I feel has the best potential to move up in price in the next 30-45 days, or less. I am not always right…which is why I trade with protection to begin with.

Side by Side Comparison of RadioActive Married Put vs. Calendar Put Spread – BABA

Only one of these two strategies carried a High Risk Zone – and we are already there.

Would the Calendar Put spread do better if the stock had stayed around $140.00? Of course. But that was not our Expectation for the stock. If I had a bearish sentiment I would consider a Calendar Put spread, a Bear Call Spread, or maybe even just buying a long put.

But the structure of the Calendar Put spread did not match my expectations. If the stock only moved up 3-4% as expected, the RadioActive Trade would be at a profit. The Calendar Put spread would be at a small loss. It’s going in the wrong direction for the structure of the trade.

Would I ever use a Calendar Put? Of course, in fact that is one of the 12 Income Methods we use at RadioActive Trading – under the right circumstances for the overall trade. But to use this structure if I am expecting the stock to move up? No, it is the wrong structure and can have disastrous leveraged losses.

So, Why Would One Consider Doing this in Place of a RadioActive Married Put?

To use less capital.  If we use less capital the trade must be better, right? Well, we have proved that it is not really the case.

To get into the stock at a discount.  Yes, if BABA was trading below $135 at July expiration, we would be forced to buy shares of stock. AND we keep the $3.55 premium. AND we have the protective put in place. If that was the case we would have:

Buy 100 shares of BABA at  $135.00 (obligation of short put)

Own DEC 145 puts at            $ 14.50

Keep JULY premium at      -$ 3.55 (from selling 21-JULY 135 put)

Total Invested =                     $145.95

Guaranteed Exit = –               $145.00

Maximum Risk =                   $ 0.95, or 0.7%

We would now be in a low risk Married Put with a better cost basis than buying the stock. BUT…in order for that to happen the stock would need to fall -3%.  We would be into the stock at a discounted price, but we would be holding a $145 put on a stock that is trading below $135.  Again, that was not our expectation for the position.

Because we all want to generate income right away!  A blessing and a curse for most options trades. There is nothing wrong with income strategies – unless they go against your original expectation. When you sell premium too soon and at too low of a price, you change the dynamic of the trade. You will likely go against your initial Expectations for the stock…and be in a loss zone rather than a profit zone. Because you HAD to generate premium. Not always the best idea.

Because as Options Traders we know we have…Options!  Thinking outside the box. Taking what you know, and applying it to better or increase profits on a new strategy. Nothing is wrong with this, in fact, I did this Calendar Put approach with my first 3 RadioActive Trades back in 2007. Guess what? I lost on all 3 where I would have had a profit by simply opening the stock and put combination. Always remember the structure of the trade, and your Expectations for why you selected the trade. Don’t handcuff yourself for the sake of getting premium NOW.

Well, this is One Comparison…

Now that we have looked at the structure of the two trades, what are we left with?

Well, the Calendar Put as a substitute for the Married put really only works if your Expectations are that the stock will move no more than +1% or -1% in the first 30 days, then will continue to move up several % or more in the following 3-4 months.

If you can pick stocks on a consistent basis (65% of the time or more) that move down slightly in the first 20-30 days, then will gain 6-8% or more in the months after that, then this will work. And, you don’t need my help to be successful at trading.

But when you are looking for a Bullish trade, and identifying bullish stocks, the protected Married Put position is the way to go.

Of course, there are other comparisons brought up as well:

Why buy the stock? Why not buy an ITM long call in place of the stock for less capital?”

Isn’t a Reverse Collar better at limiting risk than a Married Put?”

I hear you, and have heard others like you. Check out this archived webinar where we compare the ‘Poor Man’s Married Put’ (ITM Long Strangle) and the Reverse Collar against the RadioActive Married Put Position. Click HERE to view Comparison of Limited Risk Strategies.

Do you have another setup you would like to compare? Let me know in the comments!

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