Protect Your Portfolio With Married Puts

Sat, Jun 12, 2010

Investment

Many investors assume that options are complex and risky. In most scenarios, they are correct. However, there are certain uses of stock options which are quite conservative in nature, and can serve to reduce the risk already present within your stock portfolio. It is no revelation to anyone reading this that the stock market can violently go up and down like a yo-yo. Many who are investing for their retirement make the mistake of selling at the bottom — out of intense fear. The married put strategy can provide for a way to prevent this phenomenon and allow you to hold your stocks while still sleeping well at night.

A stock option gives you the right to buy or sell a given stock at a given price — for a stipulated duration. Specifically, a put option gives you the right to sell shares of the stock it represents, its “strike price” dictates at what price you have the right to sell it at, and its “expiration date” is the time during which it is valid. Assume, for example, that you own 1000 shares of ABC company, and it is now trading at $58 per share. It had tanked to $40 before and nearly scared you to death — now that it has recovered somewhat you are tempted to sell. However, you believe in the stock for the long term, but just do not have the stomach for the current volatility in the stock market.

A good strategy would be to buy puts on ABC — this technique is called “married puts” because you own both the puts and the underlying shares. Assume that puts on ABC with a 50 strike price which are valid for 6 months are selling for $2 — this means that to buy enough to cover 1000 shares it would cost you $2000. Purchasing these puts gives you the right to sell 1000 shares (the amount you own) of ABC at $50 — for the next six months. This $2000 spent equates to an insurance policy which gives you peace of mind that your worst case scenario, for at least six months, is that you will get $50 for your shares in ABC. It does not matter if it goes to zero — you are guaranteed $50 per share. This allows you to hold your position having good downside protection. The next time you feel you are letting fear dictate selling an otherwise good stock, explore married puts as a good alternative.

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