Q and A. More on Married Puts vs. Long Calls

My recent post brought a lengthy reply.


I am quite new to options trading. We have become involved with a program in the UK that calls itself The Protected Trader. It buys 100 stocks
(DJIA) [NOTE:  DJIA only has 30 stocks, but the specific index traded is not important to the discussion.]  at the same time buys a put option 5% above stock price 6month or more out with a maximum risk of less than 8%. Again at the same time sell OTM one or two month call option with 5% or greater premium.

[I took one quick look at the web site.  This is what I noticed:  A lot of hype – touting 'no risk investing.'  All by itself, that should be a warning, but to his credit, I see no promises of specific profits.  He offers a free video, so at least he is not charging too much.  He claims his fee is $10,000 for a one on one session to teach his system.  I have no idea of the value of what he teaches, but that price is unreasonable.  Period. And the 'no risk' part frightens me.]

This appears similar to the strategies put forward in the Blueprint to which I believe you allude in this blog. 

[I am unfamiliar with the Blueprint, and that is not the program I mentioned.]

Apparently you are buying puts that are already in the money, and those are costly.  Besides the intrinsic value (amount ITM), you are also paying up to 8% in time premium for a put with a lifetime of 6 months.

Next you are selling shorter-term call options that carry a time premium of 5%.

I am having difficulty visualizing this, so I went to the marketplace to look for an example.  Using OEX, the S&P 100 Index, I found:

OEX = 418

DEC 460 puts are $64.  $42 intrinsic value and $22 time value (almost 8% of the $41,800 investment).

Aug 420 calls are $23, just over 5% time premium.

If OEX crashes, the puts provide ultimate protection, limiting losses by allowing you to sell the index at 460.  Your cost was 418 + 64 – 23, or 459.  Most, if not all, of the $22 in put time premium may be lost, but you keep all $23 from the call time premium.  All in all, not a bad result in the event of a crash.  No loss, and a small gain.

If OEX surges to 500, you are obligated to sell at 420.  That's not so bad by itself, but you paid $64 for puts and collected $23 for the calls.  Of course you can still collect some cash for your puts, but it looks as if you are out a good portion of the $4,100 you paid in premium – less the $200 profit you have from buying at 418 and selling at 420.  Not a good deal.

Maybe I'm using bad numbers, but I don't see how this works in a strong market.  Sure, it works fine when the markets are steady, but buying those 6-month puts is costly.  I prefer to own a true collar in which all options expire on the same day.

The same person also wrote this response to Chris Smith's review (below) to justify married puts over long calls:

Aren’t Long Calls and Married Puts the Same Thing?  [Yes, assuming the options are priced efficiently.]

Chris Smith actually bought The Blueprint. I’m okay with his review, except he should be informed that:

1) The Blueprint’s chapters HAVE been revised to name the Income Methods with the traditionally accepted terms, so that part should be eliminated if he wants a current, accurate review and be reminded…

2) The benefit of the married put at the outset is that it defines risk more
readily, in a more understandable way for many. [I cannot deny that if it really is 'more understandable' then that would be one reason for recommending one idea over another.  But I don't see how that applies here. 

To me, buying a call and paying $5 defines the risk as $5 – and anyone can understand that.  To buy stock plus an ITM put, and pricing the put so that no more than 8% of the investment is tied up in time premium, is much more difficult for the unsophisticated trader to understand.]  

A married put is NOT the synthetic equivalent of a long call; it is the
synthetic equivalent of a long call WITH that long call having a commensurate amount of capital on deposit in a free interest account. That’s intellectual honesty. [That argues more in favor of the long call, but it's really not important.  When options are priced correctly, the cost of carrying long stock is priced into the options.  And if the stock pays a dividend, that's also priced into the options. Agree that you want your investor to understand this point and understand what he is being advised to trade, but because it should not make any monetary difference in the outcome, it's not an essential point.]

That is why the time value premium of an OTM call is always higher than the
time value premium portion of an ITM put at the same strike. The free interest rate is priced in. [When the options are priced correctly – which is almost all the time – It's not relevant when choosing which method to trade.  Because they are equivalent positions, the financial result will be the same.]

Folks that want to trade an ideal amount of risk will find that using a married put will do the heavy lifting for them intellectually. They simply decide their risk parameters and use the PowerOptions search screen… no problem. [I think I see one problem:  The need to sell the idea that others must use this search screen.  Sounds like self-promotion to me, and the truth be damned.]

At one point, Chris shared with me that he was trading an amount of $5,000
and had a $1,000 gain in the same period of time that I was trading $100,000 and had a $2,10O gain. His implication was that pure options did better. [An unreasonable conclusion, even when ignoring the important discussion below.  Was he trading the same underlying?  Did he buy/sell options at the same time at equivalent prices?  Are your commissions and other expenses equal?]

I pointed out that it might appear that way on the surface… a 20% gain versus a 2.1% gain… but that after all, his $5,000 SHOULD represent $100,000 of total trading capital because he was risking 100% of the capital that he was betting on each long call, while I was risking 5% of the capital I was betting on each married put.[Agree]

In other words, 5% of $100,000 is exactly equal to 100% of $5,000…. by that
standard, and by the dollar amount both of our accounts returned, my 2.1%, highly protected gain was greater than his highly leveraged, 20% gain. [Yes, his gain was larger, but it's not fair to label one account 'highly leveraged' and the other as 'highly protected' when in fact, the accounts are equivalent, and the risk is the same.  It's merely an illusion that he is more leveraged. 

He did find a way to mimic the performance of your portfolio with 'only' $5,000 and by the traditional definition, he is highly leveraged.  But in the context of this discussion, they own the same portfolio with the same amount at risk.  The other guy just uses less cash.  That doesn't feel leveraged to me]

If we’re going to talk leverage, let’s talk leverage. A trade that goes
against me costs 5%, the same trade that goes just as sour against a pure options guy costs 100%. [This is the epitome of illogical thought.]

100% of $5k is the SAME as 5% of $100k.  [Yes.  Is it possible that people cannot see this?  Investors have blind spots all the time, and this is just another one of those.  It never ceases to amaze me.  I've been told:  'If I own the call, my whole investment can disappear, but when I own the married put, that's not possible.'  They just don't get it.  The time decay (including interest costs) is the same.  The profit/loss is the same.  The positions are equivalent.  But the fact that one trade loses 100% blinds them to everything else.]

RadioActive Trading [This is the guy I was quoting in my post]  with a married put ENSURES that a trader, ESPECIALLY a beginner to options or to money management, does not take risks that are too big. Meanwhile, it still affords the trader the opportunity to take dividends, or to play these strategies on the company that he works for when he receives
stock as an employee benefit. [Yes, if you get stock as a benefit, it's easier to buy puts.  But that does not make it reasonable to conclude that the married put is better for all investors.  This is insulting to the investor.  He is saying that someone who would buy 500 shares of stock and five puts would not understand that the correct number of calls to purchase is five.]

The Blueprint may not be the publication of choice to the seasoned options
trader that [sic] already understands deep principles of money management, but that’s not to whom it is addressed.[OK.  But does that make it ok to mislead individual investors who are option rookies – just to sell whatever it is that he has to sell?  Telling them married puts are better than long calls is just not being truthful.]

Mainly, I’ve been trying to benefit the thousands that have been burned by
the snake oil gurus in the covered call seminars, the case for writing covered calls, ignoring downside risk. [But there are other ways to mitigate downside risk, other than the married put.  To me the collar is the best compromise, but that's for my comfort zone.  There are other choices.]

ANYway…this helps answer folks that [sic] keep coming up with the same old tired argument: Trading long calls and married puts is IDENTICAL.  [The reason it appears to be a tired, old argument is because it's the truth.  It's honest.  The truth is often boring.  I NEVER encourage anyone to buy call options as part of an investment portfolio, but that has nothing to do with the fact that the play is equivalent to owning married puts.]

Hogwash. If there wasn’t a difference than why prefer the calls? There IS a difference, and though that difference may to some only be a matter of how tommanage them… it’s that difference that makes them a simple choice for the folks to whom The Blueprint is addressed: People that heretofore have ignored or not understood the principles of safe money management. I believe in my soul that it will help those whom it’s designed to help, and perhaps the review could reflect that. [I'll grant that owning married puts is safer than owning stock.  To that extent it 'helps' those 'folks.'  But, they would be better served owning a call portfolio that's equivalent to the married put portfolio.  There is no difference – when options are priced efficiently, but it's easier to trade and easier to understand, despite his contrary belief. 

I get the 'in my soul' part.  He sounds sincere, just as I know I'm sincere.  But sometimes the most sincere guys can make mistakes, just like anyone else.  Teaching that married puts is 'better' than naked long calls is not a good thing to do.  Teach equivalence, then explain why he believes that one is more effective than the other. 

I prefer naked put selling to covered call writing – but only because it's less expensive to trade and easier to shut down the trade.  The positions are equivalent.  I would never argue that one is 'better' – just more efficient. 

It appears to be the same here.  He knows they are the same, but refuses to admit it because he prefers to trade the married put.  He has a vested interest in convincing others that the MP is better, and that vested interest makes him like any other salesman – he pushes what benefits himself.   He doesn't want to recommend buying calls because it's possible for the investor lose it all.  It's easier for him to go for the married put where losses are limited – even though the dollars lost are identical.]

Mark, we are trying to learn these strategies to assist with capital accumulation and/or income. Do you feel that they are flawed and if so could you indicate why so that we can understand as it is difficult to get independent information.

[If you don't like the idea of investing all your assets into owning naked calls – and I surely don't, then there is no reason to like the idea of owning married puts.  But earlier you mentioned the extended collar.  I think that type of collar has too much upside risk, as detailed above, but I do believe that collars are the investment strategy that can work for you. Excellent protection, limited profits.  Much will depend on your ability to manage positions and risk, but if there is one (and I'm not saying there is) strategy that requires minimum  risk management, it's the collar.  if you go that route, be certain you understand pin risk.  That can be a problem.

One more thought.  You can open paper trading accounts and practice a variety of alternative positions at the same time that you are managing your real money.  That will give you an opportunity to try collars, extended collars, married puts, and anything else that occurs to you.  If you go that route, give yourself a year before deciding any one specific strategy looks better than another.



P.S. Pin risk is carefully described in The Rookies Guide to Options.


6 Responses to Q and A. More on Married Puts vs. Long Calls

  1. rluser 05/15/2009 at 9:40 AM #

    [The reason it appears to be a tired, old argument is because it’s the truth. It’s honest. The truth is often boring. I NEVER encourage anyone to buy call options as part of an investment portfolio, but that has nothing to do with the fact that the play is equivalent to owning married puts.]

    I think you might like to reword this or qualify it to avoid accusations of intellectual dishonesty. I am thinking specifically of your advocacy of insurance.

  2. Mark Wolfinger 05/15/2009 at 11:03 AM #

    I never encourage anyone – in fact, I am strongly opposed to the idea – to buy call options AS A DIRECTIONAL PLAY.
    Buying insurance is not a directional play.
    And if you want to quibble over wording, then ‘buying options as insurance’ is not the same as buying options ‘as part of an investment porfolio.’
    I don’t encourage the purchase of naked put options as a directional play either, but I do buy homeowners and auto insurance. It’s just not the same.
    In the penultimate paragraph, I specifically state that I don’t like the idea of owning naked calls (ok, that statement is qualified by saying ‘all assets.’), so I fail to see any sense of intellectual dishonesty.

  3. Income Trader 05/15/2009 at 1:56 PM #

    Hi Mark,
    I see you are up and running at Tradeking as an All-Star!
    I frequent the forums there and I look forward to reading your posts.

  4. Mark Wolfinger 05/15/2009 at 2:47 PM #

    Hey IT,
    I’m hoping to reply to rookie questions, but I’ll have to see what coems my way.
    Thanks. BTW, I have not seen either of the two responses I submitted. Just the notification that I joined the team.

  5. TR 05/15/2009 at 4:38 PM #

    Hi Mark
    I have been using an approch of “time diversification” with RUT IC’s. Roughly every week I have been buying 1 lot of a RUT IC with short strikes at a delta of about 10. It is very early but so far I am happy with this approach. I closed my 2 June positions with profits of $1.20 and $1.30 which I am happy with.
    I am also fairly happy with my July positions from the perspective that my risk curve (IB risk analyser) is very balanced and in line with my ambivalent view on market direction. I do however have little area of concern that I want to ask you about, which is related to something you somewhat predicted before I started this “time diversitification” strategy.
    So here’s my situation with the July RUT IC’s…1) I first bought a 1 lot of 360/370/590/600. 2) Next 1 bought a 2 lot of 380/390/590/600. 3) next I bought 1 lot of 400/410/590/600. 4) Finally I bought a 1 lot of 370/380/580/590
    What this leaves me with is:
    1 360/390 PUT SPREAD
    1 380/390 PUT SPREAD
    1 400/410 PUT spread
    3 590/600 call spreads
    1 580/600 call spread
    My question to you is am I putting myself at significant risk with the 360/390 PUT spread. It seems 3 PUT spread purchases have cascaded to create a 30 point spread. My risk management game plan was to close the position when the short strike is breached. My concern is that buying a 360/390 could be costly when RUT is at 390.
    What are your thoughts? Any suggestions? Am I overthinking this?

  6. Mark Wolfinger 05/15/2009 at 9:07 PM #

    See blog post (5/16/2009):
    Q & A. Overlapping Iron Condor Positions