Ah, just reveling in the morning after the FORT – Foundations Of RadioActive Trading Seminar. Here’s a question that came up, and that merits a good answer:
“Aren’t protective puts EXPENSIVE?”
Well… yes and no. I mean, they do cost money. The question should be phrased more like this: “Are protective puts WORTH what they COST?”
Better question, I think. Because guess what – the benefits FAR outweigh the costs. Plus, the put option may actually become a source of income…
IN the meantime, consider coming to any of our twice weekly Webinars. We’ll show three ways that the put can actually be a source of income in a married put trade.
The Blueprint contains ten income methods for taking money out of a married put (protective put) trade… five of which DEPEND on having a put in place already. But even without going into the fact that you can take income from married put trades in unique ways that manipulate the put option, let’s consider just the merits of trading with protection.
Everybody knows this about insurance and lawyers: better to have them and not need them, than to need them and not have them!
No reasonable person reading this post would invest in a piece of real estate that wasn’t insured. No bank would loan on a house or car that wasn’t insured. No business owner in his right mind would conduct business without at least liability insurance. So… what’s the big fuss about using puts to protect stock? I wouldn’t even THINK about trading without them.
Consider the two situations below. They are both true stories. One shows a losing stock with a put added and how it saved my bacon… and one shows a winning stock with a put added, and whether or not that was wise.
DRIV. I get into Digital River at $38.53. At the same time, I pick up an insurance policy… an in-the-money, Jan 2010 $45 protective put. What’s my expense? $9.20. “Wow”, you night be saying. “That’s a LOT.”
Is it? Hmmm…
October 12, 2009: DRIV GAPS down from $40.42 to $25.12 overnight… keeps heading down to a low of $23.82. It still has not recovered as of this writing in late February; DRIV is in the mid-twenties. Cost of trading this issue WITHOUT a protective put: $38.53 – $25.00 = $13.53 per share. That’s an overnight, over 35% gap.
Let’s compare that with the cost of the Jan 2010 $45 protective put. YES, I spent $9.20 for it… but I was always guaranteed to get most of that back. It’s like money in the bank. Look here:
DRIV stock per share $38.53
Cost of protective put +$ 9.20
Total Investment $47.73
Guaranteed Exit Price -$45.00
Total Amount AT RISK $ 2.73
See that? While it APPEARS as though I’ve SPENT $9.20 for the protective put, in truth I’ve only parked it for a bit. Most of thst value of that put is stored, intrinsic value that I’m guaranteed to get back.
And I did. SO, while some folks were licking their wounds, wondering where their $13.53 (35%) a share went, I was okay losing $2.73 (5.7%) and going my way looking for a winner.
Let’s look at this in terms of value: $13.53 loss vs a $2.73 loss is a $10.80 difference. Do we still think puts are expensive?
😉
Well, maybe that’s not fair. Maybe you were thinking more along the lines of, “Hey, I usually pick winners. SO using a protective put would needlessly cut into my profits!”
Well, okay. Since you have a crystal ball, I guess you never need a protective put. But! Let me tell you about this one anyway:
CREE I got into CREE at $51.73 a share and simultaneously picked up a June 2010 $60 put for 11.60. Let’s use the “five lines” RadioActive Profit Machine setup again:
CREE stock per share $51.73
Cost of protective put +$11.60
Total Investment $63.33
Guaranteed Exit Price -$60.00
Total Amount AT RISK $ 3.33
SO… On January 19, we’re expecting an earnings announcement just after the bell. Brigantine Advisors CUTS its rating of CREE from Hold to Sell during the day. I decide to hold anyway, having less than a thousand bucks (I bought 300 shares and 3 puts) AT RISK.
Know what? One of my clients had bought CREE earlier and got puts at a better cost basis. He was going into this earnings announcement BULLETPROOF… meaning that the combined cost of his CREE shares and his protective, $60 puts was LESS than $60. He couldn’t lose!
SO the announcement comes out and it’s GOOD. Next day, CREE shares shoot up to $63.95. It’s been going up since. Let’s look at the collective position today:
CREE stock per share $65.40
Value of protective put +$ 3.80 (bid)
Total Value $69.20
Original Investment -$63.33
Total Profit if sold now $ 5.87
Wow, a $5.87 per share gain instead of a $3.33 loss. There’s a skewed risk/reward picture, the only kind I like to trade. Now, sure… I know that if we didn’t have the put in place, the profit would have been bigger…
…but who has the intestinal fortitude to hold CREE through the earnings announcement… with an analyst downgrade during the trading day before said announcement… especially if he played DRIV recently and it dropped 35% overnight?
I’ll tell you who… I would. So would my client that called after the announcement and said, “Thank you… RadioActive Trading has changed my LIFE!” This because he was able have NO WORRIES after the bell, being long on a volatile stock with so much buzz on both sides. Up til recently holding positions overnight was stressful, but not any more. He was BULLETPROOF.
Actually, because of the “Income Methods”… adjustments that I’ve made to the position at a credit… my CREE position is bulletproof as well. That means I still have the upside way open, but no risk at all left in the trade. It’s going to make for a very peaceful night of sleep for me before CREE’s next earnings announcement in April.
Only my Fission‘ Members get to see the details of how I bulletproofed CREE using the ten Income Methods of The Blueprint… but you can check out a “virtual” CREE position by going to the Plain Vanilla Portfolio on http://www.radioactivetrading.com.
Okay, gang, fire away! Tell me what you think about trading stock with an insurance policy… the “married put” or “protective put” position.
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
It seems to me that the primary advantage to your system is to protect against a large drop in the value of a stock. Usually this happens after a disappointing earnings announcement. If you use a traditional stop of 5-6 %, but make sure you do not hold a stock over earnings, the potential large decline is eliminated thus you will be able to gain all of the upside and still have a stop in place. this assumes you reenter your position after earnings or you just avoid buying any stock prior to earnings.
…The problem with using a “stop loss” trigger is, …a lot of time these reactions are the knee-jerk reactions. Meaning, the anouncment come out less-than-favorable, there is a sell-off in the market, your stop is hit for a 5-6% loss [stop running?]… then the buyers re-enter. At this point you are playing catch-up.
*IF you had a 3-month-out Protective Put in play, you still have time to make adjustments [money] to your account.
*IF the market continues to “tank”… your loss% is PRE-calculated.
*IF it is the typical knee-jerk reaction and the market movers are taking out stops …just to turn around and buy back-in at a lower price [in turn move the market right back up], then you have nothing to worry about ..YOU decide when you want to get out. In this case… you would have never been “taken-out”.
*AND… You don’t have to be glued to your trading screen to see if you will be “stopped-out” just to re-enter. [you have weeks,or even months, to make this decision].
I used to use stop-losses for years. No more. With the Protective Put [coupled with a few other simple adjustments …OR just by themselves alone], there is just no better way [imho].
i think buying a stock and doing a married put is a poor strategy…..let’s look at the radioactive philosophy…..time value and money at risk?
let’s say you bought a etf like iwm….and was at 62 and you according to radioactive was going to buy the jan12-70 (ditm) put……just buy the stock…and sell covered calls……put a contingent order in so that if iwm drops 10% you purchase the same 70 strike put you were thinking about…..if the stock drops 10% and you purchase the put at strike 70….the time value is 25% or more less and therefore your at risk is lower…so why buy the protection immediately and have more at risk?
Hi Joe,
The answers to your questions are in the question itself.
1) You are making the assumption that I would trade IWM that deeply in the money. I wouldn’t.
2) You have never been whipsawed or been long during a black swan event or you would never have offered an example like this.
On a whip down, then back up you would be filled on your put at a bad price, get stopped out of your stock, or both.
Also, whenever you say “Sell covered calls” just substitute the words “sell naked puts” and see how much sense that makes in a whipsaw.
My married put strategy does very well, thank you. It keeps me out of trouble when a stop order can’t, and takes advantage of the moves UP without limiting growth like a covered call does.
Check out the math! Covered call selling might seem sexy but long term it’s a losing proposition.
Happy Trading,
Kurt
I was wondering do you ever do ‘married calls” with short positions?
Thanks
Harvey
Married calls are definitely a possible way to play the bearish markets. Another choice would be to just buy a put option and put the rest of the cash into something interest bearing with minimal risk. Just keep in mind that when you short stock there are other fees involved like margin interest.
I tried doing married ATM using weekly options on ES futures for example for 24 hrs left until expiry cost was around 4 point ($200) all time value.. but the problem is in 24hrs even if ES moves in my desired direction it not move enough to recover the cost of the PUT
Reason for using and futures as underlying is built in leverage and with married put yu get cross margin advantage.. so how would this work? if
Hello Mike, sorry, we had a problem with our notifications and I did not see your comment until now.
ATM puts have the highest time value of any of the puts with the same expiration date. As you go ITM, the put price increases but most of that is intrinsic value that you are guaranteed to get back. OTM options have a lower time value (extrinsic value, if you prefer), but offer a higher risk as the insurance will not kick in until the stock reaches that strike.
So, with ATM options you are fighting a higher time value decay. You went shorter term for a lower cost, but now you have less time for the stock to move in your direction.
Lastly, we have never used this structure with Futures ourselves. The benefit of RPM techniques is that you can control risk to single digits by owning the stock and insuring the position with the put option. If you do not own the underlying in a Futures position, you either have a straight put (bearish) or if you bought a Futures call you now have a Long Strangle or Straddle position, which is a different approach and carries leveraged risk.
Thank you for the comment, and I am sorry for the delay in response!
Yes you are correct when you say “You went shorter term for a lower cost, but now you have less time for the stock to move in your direction.” but what would be an alternative? Using ES futures as underlying ( LONG ES + LONG PUT ( ITM as per your strategy ) What duration would you use? What would it look like as compared to Short dated ATM put!
In my example I am also long underlying futures (just the way you would be long underlying stock) not just buying the PUT so the question of “not own the underlying in a Futures position” does not arise!
By the way reason you are using Equity instead of Futures is ?
For example instead of say SPY one can use ES both based on SPX index
Using Es as underlying is internal leverage ( and in this case since you are hedging that leverage should not increase your risk + ,Cross Margin efficiency)
TO hold 125000 worth SPY you need either 125K or 50% of it
TO hold same 125K in ES you need $4500 or perhaps even less becasue of the LONG option!
The main questions I had were
1) time decay of the Option
2) when things go wrong when the underlying does not move in desired direction? do you hold both positions until expiry!
Hello Mike,
The decision on selecting which put strike price to use to hedge an investment comes down to:
1. How much you want to protect in the case of a decline
2. When you think or fear the decline may happen
3. The severity of the decline
4. And, how long you are planning on holding the investment
Here at RadioActive Trading the positions we set up are long term holdings. We expect growth in the position and likely plan to be in the underlying for 4-5 months, potentially longer.
Buying the equity outright and the put option to directly cover the security and keep the risks to single digits.
Although you can enter ES at a leveraged price and only use $4,500 to control $125K, the insurance you would want to purchase should still cover the $125K – not the $4,500 in margin. Although no one is immediately expecting a -10 to -20% instant, overnight decline in SPX / SPY, anything can happen.
If you were planning to hold the ES Futures to say December or further, you would want insurance that covers the expected hold time of the position. When I open a new security for Fusion subscribers I am going at least 150 days out in time with the put option, and going slightly ITM to control risk to only 4-8% of the investment.
SPY is different than most securities due to the low volatility. If I did open an Married Put on SPY now I would likely:
Buy shares of SPY at $253.81
Buy 16-MAR (162 days) 255 put at $7.88
Total Invested = $261.68
Guaranteed Exit = -$255.00
Max Risk = $6.68, or only 2.6% if investment. All I am risking is the Time Value / Extrinsic Value of the Put, or $6.68. For 162 days of insurance, that is a risk of $0.04 / day.
Now, you could buy a cheaper SPY put in OCT, using an ATM strike.
20-OCT 254 put on SPY at $1.27. Risk is $1.07, or 0.4%. For 15 days of insurance, that is $0.07 / day.
Let’s say on OCT 20th, SPY is trading right around $254. Your cheap put expires and you added a cost basis of $1.27 to the position. You now buy a 3-NOV 254 put for $1.27 again, making the total cost into insurance $2.54. Then it stays at $254 again, and so on. If you bought ATM puts 15 days out in time at $1.27, you would pass the $6.68 cost basis for the further out put (March expiration) in 75 days…right around December expiration. This would be 5 purchase cycles at $1.27 per put – or $6.35 on insurance.
If SPY was trading at $254 through DEC expiration, the March put would still have a value (theoretically) of $5.25 as there is still 3 months remaining…so I would only be losing $236 on the total investment 0.9% on the investment. You would have paid out $6.35 total over the last 75 days buying cheaper, shorter term puts, and be at a loss of -$6.15, or 2.4% of the total invested.
But, if you were only planning on staying in the position for a month or 30 days, you would look to insure your position – either direct or leveraged – with the put that best suits your needs, expectations and goals. Of course it is unlikely that SPY would stay at $254 for 75 days straight, this is just to show the comparison of the two options. ATM options have the highest time value / extrinsic value compared to any other option in the same expiration cycle. Far out options are higher priced, but have a lower cost per day compared to near term options. You get a better annualized return selling week by week or month by month; you get a lower annualized cost buying options that are further out in time. The option that is 6 months out in time will not be 6X the cost of the 1-month out option at the same strike.
To answer your two points directly:
1). Time decay is more rapid for the near term options, and will have a higher cost per day. ATM options have the highest time value of any corresponding options with the same expiration date. Although further out in time options will have a higher time premium, the decay per day will be lower.
2). If the stock stays the same or moves down, I will use one of the income methods discussed in The Blueprint to adjust the position. Of the 12 income methods some are used if the stock moves up, some are used if the stock stagnates and others are used if the stock falls and is going in the opposite direction. Very rarely will we hold a position all the way to expiration.
Remember the view of the SPY RadioActive Trade at December: If the stock stagnated for that long I could still close both legs and potentially have a loss of less than -1.0%. I might exit at that time rather than hold to March and risk the full 2.6% or so. OR…I could adjust the position based on Market Conditions, My Expectations and My Goals for the trade (What we call the CEGA model that we apply before deciding which income method to use).