Married put strategy

Mark D Wolfinger on

With the volatile market we have seen lately, I am becoming risk averse. Is it a good risk averse strategy to buy a married put that expires in a couple years, and then sell covered calls just going out 1 or 2 months at a time. Is there an easier and better strategy than what I just described?

Thanks,
Rob

Hello Rob,

Risk adverse is a good idea in any market (IMHO).

Your selected method is much less risky than many other strategies. But, there is no guarantee of profits.

Some positions are equivalent to other positions. That means they have the same risk and same reward. One such equivalence is the married put and the call.
Thus, if you buy one call option, you own a position that's equivalent to owning 100 shares of stock plus one put (married put) - if the put and call have the same strike price and expiration date.

You can buy a LEAPS call option instead of the married put. If you do that and then sell short-term 'covered calls' you would be adopting a fairly common strategy. Here are some things to consider:

The name of this strategy is 'calendar spread.' You would own a LEAPS option and write a nearer-term option. If the strike prices are not identical, then it's not technically a calendar spread, but it does work the same way. You can read about calendar spreads here: http://blog.mdwoptions.com/options_for_rookies/2008/10/calendar-spreads-part-i-1.html (There are five parts.)

The calls are no longer 'covered' because you don't own stock. But that's just nomenclature. It does not make any difference.

If you prefer to own the married put, that's fine. You would collect dividends, if any, but would be paying interest to own the shares. Be certain to include that 'cost to carry' the position when deciding if the married put or the LEAPS call is better for you to own. If you choose the married put, the position would be a 'collar.' The collar usually has options that expire in the same month, but it's not a necessary condition. see: http://blog.mdwoptions.com/options_for_rookies/2008/07/collars-the-ult.html and http://blog.mdwoptions.com/options_for_rookies/2008/07/example-of-a-co.html

The put does offer excellent protection if the stock price tumbles. That's good.

If the stock surges past the strike price of your short calls, this position does not perform as well as a covered call. That means there is some risk to the upside that does not exist with the covered call. yet, you gain so much safety to the downside, that for most conservative investors this is a reasonable trade-off.

There is one additional risk to this position. Because you own long-term options (either puts or calls), you have a position that is long vega. Vega is a measure of the volatility component in the price of an option. In simple terms, if the implied volatility of the options increase, you gain. If IV decreases, you lose some money. This is not a warning against adopting this strategy, but you must be aware of the risks and rewards before adopting any method. Your broker should provide data that tells you an option's vega - allowing you to get a good feeling for how much you have to gain or lose due to a change in implied volatility.

Mark

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Mark D. Wolfinger
The Rookie's Guide to Options:
The Beginner's Handbook of Trading Equity Options
website:  http://www.mdwoptions.com
blog: http://blog.mdwoptions.com/options_for_rookies
Free eBook: http://www.mdwoptions.com/freebook.pdf

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