In a married puts option strategy, the investor owns shares of stock and purchases an equal number of put options. Once the stock rises by more than the purchase price of the put option, the investor has unlimited upside. If the stock declines, the investor is protected by the puts and the down side risk is limited. There is a cost associated with the put protection and if the stock stays flat, the strategy will lose money. For instance, let’s say that the stock is trading at $50 and a $50 put with three months of life is trading for $3. The position costs $53 ($50 + $3) to establish. If the stock moves above $53, the cost of the put option will be offset by the gain in the stock and the upside is unlimited from that point on. If the stock drops below $50, the investor can exercise their right to sell shares at $50. Hence, the downside risk is $3 ($53 – $50). This same position is also called a synthetic call. A call purchaser has unlimited upside once the cost of the call option is covered. The downside to a call option purchase is limited to the purchase price of the call. In this case, a $50 call with 3 months of life would cost $3. With the stock trading at $50, the put and the call have to be trading at the same price or arbitrage would exist. Married puts and buying calls are two are equivalent option strategies. Instead of buying the stock and the put, an investor simply buys the $50 call option with the same expiration month. One advantage of the married put position is that the investor collects dividends. One downside is that it requires more capital than simply purchasing a call. A call purchaser also earns interest on the cash balance that is not tied up in the stock.
January 3, 2009
Mini Lessons September 21, 2022