A long call and a married put have the same risk-reward profile, but they are only 'parity' trades if the investor applies proper discipline.
Stock + Long Put does not equal Long Call. Stock + Long Put = Long Call + Cash to buy stock on hold in an interest bearing account.
For this example, let's say we have two accounts with a total value of $20,000, and $5,500 of free capital to invest. In one account, Portfolio 1, we buy 200 shares INTC @ $24.50 and 2 OCT 25 puts @ $1.72. The total investment for INTC in Portfolio 1 would be $5,224, but we are guaranteed to get $5,000 back. Yes, over 1/4th of our total portfolio is invested in one position, but the most we could lose in Portfolio 1 is $244, or 1.2% of our total portfolio value.
In Portfolio 2 we buy 2 OCT 25 calls @ $0.80 (as stretcho44 mentions the dividend was priced into the puts, so the calls have a lower time value). You would now only have $160 at risk, or only 0.8% of the total portfolio value. So...long calls are the better trade, right? Not really. Portfolio 2 still has $5,340 of free capital to invest. The nature of the investor is to take that remaining capital and buy 3 calls of ABC, 5 calls on XYZ, 6 calls on stock 123, etc. The moment the investor in Portfolio 2 starts using the remaining capital to buy calls on other stocks or invest in other positions the INTC long call position is no longer at parity with the married put. The long call investor, Portfolio 2, would now have more of their capital at risk in the market.
The 'parity' trade to the married put would be to buy 2 OCT 25 calls @ $0.80 and at the same time put the $4,900 that it would cost to buy 200 shares of INTC on hold in an interest bearing account. Now in each portfolio we are only risking about 4% of the $5,500 free capital we had to invest, which is roughly only 1% of the total portfolio value at risk in INTC.
Thanks for the comment! The long call profit and loss chart is similar to the married put p/l, but the long call by itself is not a true parity trade to the married put position.
The true parity trade to the married put is a long call + depositing money that would have been used to buy shares of stock in an interest bearing account. The risk with using long calls is over trading or over leveraging your position.
With this married put setup we would invest $19,308 but would only risk $2,308 of that investment, or 12%. Yes, if you purchased one long call you would only be risking $2,270. However, let's say both you and I had $100,000 accounts and $20,000 in free capital. If I entered this married put above I would have invested about 1/5th of my capital but I am only risking 2.3% of my total portfolio. The married put forces us into an ideal sized trade, emphasizing proper position sizing.
If you purchase 1 SEP 170 call for $22.70, you are investing 1/10th of your free capital and risking 2.27% of your $100,000 portfolio. But, what do you do with the other $17,730 of free capital? Most investors will now buy 3 calls of XYZ, 5 calls of ABC, 4 calls of 123, etc. This leaves most of their $20,000 in free capital exposed in the market with the potential to lose 1/5th of their total account value if there is a drastic market turn. Thus, we are no longer at parity as too much of the portfolio is at risk.
If you use long calls you have to practice discipline, money management and proper position sizing in order to avoid leveraged losses.
The put can be manipulated (meaning rolled up or down) as the stock fluctuates in price. In general we would not hold the put option to July expiration without making an adjustment or reducing the initial at risk.
The reason we prefer to use the far out in time put option is that the rate of time decay is lower for the first few months. We will start to see a rapid time decay in the last 60 days to July expiration, so we would plan to close or roll the put option before that time to avoid rapid decay.
Exxon Mobil - Natural Gas Options Play [View article]
Hello bzl14,
The XOM position is profitable. The put does not decay 1:1 with the stock, and the married put play described above has a positive delta as the stock increases. Now, we won't make a 1:1 gain with the stock increase due to the price of the protective put, but right now there is still a profit on the position, and a chance to make several adjustments now that the stock has moved up in price.
Yes, a naked put trade would have yielded about a 1% profit (selling for JAN expiration and then maybe rolling to FEB), but you are taking on a lot of risk if XOM had gone the other direction.
Be careful with thinking that 85% of all options expire worthless. That statement was proven false by the CBOE a few years ago. Only about 30% of all options expire worthless. The rest are closed for a gain or loss prior to expiration, or rolled to minimize losses or try to increase gains.
Every investor has their own tolerance for risk-reward. If we were considering entering a bull put credit spread on SLW, we would use our tools at PowerOptions to identify spreads that are a reasonable percentage OTM, have our desired minimum net credit, diff. in strike prices and probability level. If you look through our past articles we recently discussed the criteria for such a spread on Priceline - PCLN. The title of the article was 'Taking an investment trip with Priceline'.
Remember, the preferred OTM bull put spreads typically come with a 5:1 or 10:1 risk-reward ratio. This means that if the maximum loss is realized on one spread you may wipe out 5 or 10 previous gains. Also, be careful when using leveraged spread trades as you do not want to over invest and risk too much capital in any one position.
The great thing about options is that they give us, well, options. There are many ways to skin a cat and take advantage of a bullish sentiment. The benefit of this setup is that we still have an unlimited upside profit potential where as any spread caps / limits the upside gains.
With current prices, you would pay $17.55 per contract for the 2014 JAN 20 call and receive $5.05 for the 2014 JAN 40 call. This would result in a net debit of $12.50, or $1,250.00 per 1 contract. The net debit is the maximum risk, which is about 4X the monetary risk of the married put position with 100 shares and 1 put contract.
Although it is unlikely that SLW would drop below $20.00 per share in 2014, we still have to compare the direct risks. The other inherent risk with using a leveraged spread is the capital invested. If we open the married put with 100 shares and 1 put, we would have a total cost of $4,248.00, but we are only risking 8.2% of that capital. If you invested the same capital into the bull call spread you could enter a 3 contract spread, costing $3,750.00, but you are risking 100% of that capital invested.
The maximum profit on the spread is $7.50, which represents a 60% gain on the leverage amount invested. However, with this far out spread the maximum profit would not be realized until you are closer to expiration, roughly 13 months from now.
Not at all. As you can see by the Profit and Loss chart in the article the married put setup provides us with an insured stock position. We are able to leave the upside while limiting the losses to single digits if we are wrong. If we entered the position as a covered call or a naked put play, we would cap our gains to only 2-3% while risking up to 97% of the invested capital.
Delving deeper into this trade, yes, the put option will decline as the stock moves up in price. Since we are using a long term, ITM put option the put will not decay 1:1 with the stock. We still have a positive delta on the position as the stock gains in value. On the flip side, if we are wrong or there is a collapse in SLW, we are only risking 8% of the invested capital in the absolute worse case scenario. We have built a fence around SLW and can use other options plays to help pay for the cost of the insurance and eliminate the initial at risk amount.
Thanks for the comment, and let me know if you if you have any further questions about the married put setup.
Yes, the mining companies are corporations and must deal with the issues you outlined, as does any corporation. We agree with you that the mining ETFs are a less volatile and perhaps more conservative way to track the metal prices, but investing in the mining stocks with this setup gives us the opportunity to perhaps generate more income and reduce the initial at risk.
As the more volatile mining stocks, such as SLW, fluctuate in price we can use 11 different adjustments following the RadioActive Trading techniques to generate income, lower the initial at risk and potentially cancel all of that risk while still leaving the upside open. If we are wrong and the stock collapses, we are comforted knowing we are only risking 8% of our entire investment.
Here's to continued 'calm seas and clear skies' for your portfolio, and to the rum never being gone.
Trading Plan: Exit Strategies For Bull Put Credit Spreads [View article]
Hello djohnsonhot,
You are correct, in fact we strongly advocate that you should never enter a naked put, bull put or bear put debit spread unless one was prepared to own the stock. In the first part of this article we reviewed some of the recent bullish components of PCLN. Due to the high stock price of PCLN we discussed the potential of this leveraged bull put credit spread to take advantage of the bullish sentiment without putting up the large amount of capital to purchase shares of stock or sell a naked put.
But your point is indeed essential as we must be aware of the possibility of being assigned early on the short put and thus having to fulfill our obligation to buy shares of stock at the 600 strike.
Trading Plan: Exit Strategies For Bull Put Credit Spreads [View article]
Hello Common Cents,
In the article we did mention that 'these are some basic adjustments that may be considered' for the spread position. We wanted to keep the discussion simple and basic as you mentioned, and perhaps follow up at a later time with a discussion of the Greeks for various spreads.
Over the years I have found it easier and more successful to manage short term spreads based on the values discussed, though management techniques for diagonal and horizontal time spreads, as well as mult-leg spreads greater than two legs, require a more intense view of the Greeks for trade entry and adjustment.
Trading Plan: Exit Strategies For Bull Put Credit Spreads [View article]
Hello Common Cents, at times we have used a delta requirement / filter of only looking for spreads where the short option delta is less than 0.30 (for a bear call spread) or greater than -0.30 (for puts). A management technique that may be used is if the option delta reaches 0.35 or 0.40 we may look to adjust or close the position.
I personally have not used other Greek values for managing a spread. However, if we see a shift in implied volatility from one day to the next we may have to re-evaluate the underlying and the spread position if new concerns have emerged while we are in the trade.
Have you used other Greek values for your spread adjustments?
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A long call and a married put have the same risk-reward profile, but they are only 'parity' trades if the investor applies proper discipline.
Stock + Long Put does not equal Long Call.
Stock + Long Put = Long Call + Cash to buy stock on hold in an interest bearing account.
For this example, let's say we have two accounts with a total value of $20,000, and $5,500 of free capital to invest. In one account, Portfolio 1, we buy 200 shares INTC @ $24.50 and 2 OCT 25 puts @ $1.72. The total investment for INTC in Portfolio 1 would be $5,224, but we are guaranteed to get $5,000 back. Yes, over 1/4th of our total portfolio is invested in one position, but the most we could lose in Portfolio 1 is $244, or 1.2% of our total portfolio value.
In Portfolio 2 we buy 2 OCT 25 calls @ $0.80 (as stretcho44 mentions the dividend was priced into the puts, so the calls have a lower time value). You would now only have $160 at risk, or only 0.8% of the total portfolio value. So...long calls are the better trade, right? Not really. Portfolio 2 still has $5,340 of free capital to invest. The nature of the investor is to take that remaining capital and buy 3 calls of ABC, 5 calls on XYZ, 6 calls on stock 123, etc. The moment the investor in Portfolio 2 starts using the remaining capital to buy calls on other stocks or invest in other positions the INTC long call position is no longer at parity with the married put. The long call investor, Portfolio 2, would now have more of their capital at risk in the market.
The 'parity' trade to the married put would be to buy 2 OCT 25 calls @ $0.80 and at the same time put the $4,900 that it would cost to buy 200 shares of INTC on hold in an interest bearing account. Now in each portfolio we are only risking about 4% of the $5,500 free capital we had to invest, which is roughly only 1% of the total portfolio value at risk in INTC.
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Thanks for the comment! The long call profit and loss chart is similar to the married put p/l, but the long call by itself is not a true parity trade to the married put position.
The true parity trade to the married put is a long call + depositing money that would have been used to buy shares of stock in an interest bearing account. The risk with using long calls is over trading or over leveraging your position.
With this married put setup we would invest $19,308 but would only risk $2,308 of that investment, or 12%. Yes, if you purchased one long call you would only be risking $2,270. However, let's say both you and I had $100,000 accounts and $20,000 in free capital. If I entered this married put above I would have invested about 1/5th of my capital but I am only risking 2.3% of my total portfolio. The married put forces us into an ideal sized trade, emphasizing proper position sizing.
If you purchase 1 SEP 170 call for $22.70, you are investing 1/10th of your free capital and risking 2.27% of your $100,000 portfolio. But, what do you do with the other $17,730 of free capital? Most investors will now buy 3 calls of XYZ, 5 calls of ABC, 4 calls of 123, etc. This leaves most of their $20,000 in free capital exposed in the market with the potential to lose 1/5th of their total account value if there is a drastic market turn. Thus, we are no longer at parity as too much of the portfolio is at risk.
If you use long calls you have to practice discipline, money management and proper position sizing in order to avoid leveraged losses.
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Intel's Transition [View article]
The put can be manipulated (meaning rolled up or down) as the stock fluctuates in price. In general we would not hold the put option to July expiration without making an adjustment or reducing the initial at risk.
The reason we prefer to use the far out in time put option is that the rate of time decay is lower for the first few months. We will start to see a rapid time decay in the last 60 days to July expiration, so we would plan to close or roll the put option before that time to avoid rapid decay.
Exxon Mobil - Natural Gas Options Play [View article]
The XOM position is profitable. The put does not decay 1:1 with the stock, and the married put play described above has a positive delta as the stock increases. Now, we won't make a 1:1 gain with the stock increase due to the price of the protective put, but right now there is still a profit on the position, and a chance to make several adjustments now that the stock has moved up in price.
Yes, a naked put trade would have yielded about a 1% profit (selling for JAN expiration and then maybe rolling to FEB), but you are taking on a lot of risk if XOM had gone the other direction.
Be careful with thinking that 85% of all options expire worthless. That statement was proven false by the CBOE a few years ago. Only about 30% of all options expire worthless. The rest are closed for a gain or loss prior to expiration, or rolled to minimize losses or try to increase gains.
Google: Another Long Straddle [View article]
Google: Another Long Straddle [View article]
Google: Another Long Straddle [View article]
Silver Sky For Silver Wheaton [View article]
Every investor has their own tolerance for risk-reward. If we were considering entering a bull put credit spread on SLW, we would use our tools at PowerOptions to identify spreads that are a reasonable percentage OTM, have our desired minimum net credit, diff. in strike prices and probability level. If you look through our past articles we recently discussed the criteria for such a spread on Priceline - PCLN. The title of the article was 'Taking an investment trip with Priceline'.
Remember, the preferred OTM bull put spreads typically come with a 5:1 or 10:1 risk-reward ratio. This means that if the maximum loss is realized on one spread you may wipe out 5 or 10 previous gains. Also, be careful when using leveraged spread trades as you do not want to over invest and risk too much capital in any one position.
Silver Sky For Silver Wheaton [View article]
The great thing about options is that they give us, well, options. There are many ways to skin a cat and take advantage of a bullish sentiment. The benefit of this setup is that we still have an unlimited upside profit potential where as any spread caps / limits the upside gains.
With current prices, you would pay $17.55 per contract for the 2014 JAN 20 call and receive $5.05 for the 2014 JAN 40 call. This would result in a net debit of $12.50, or $1,250.00 per 1 contract. The net debit is the maximum risk, which is about 4X the monetary risk of the married put position with 100 shares and 1 put contract.
Although it is unlikely that SLW would drop below $20.00 per share in 2014, we still have to compare the direct risks. The other inherent risk with using a leveraged spread is the capital invested. If we open the married put with 100 shares and 1 put, we would have a total cost of $4,248.00, but we are only risking 8.2% of that capital. If you invested the same capital into the bull call spread you could enter a 3 contract spread, costing $3,750.00, but you are risking 100% of that capital invested.
The maximum profit on the spread is $7.50, which represents a 60% gain on the leverage amount invested. However, with this far out spread the maximum profit would not be realized until you are closer to expiration, roughly 13 months from now.
Silver Sky For Silver Wheaton [View article]
Not at all. As you can see by the Profit and Loss chart in the article the married put setup provides us with an insured stock position. We are able to leave the upside while limiting the losses to single digits if we are wrong. If we entered the position as a covered call or a naked put play, we would cap our gains to only 2-3% while risking up to 97% of the invested capital.
Delving deeper into this trade, yes, the put option will decline as the stock moves up in price. Since we are using a long term, ITM put option the put will not decay 1:1 with the stock. We still have a positive delta on the position as the stock gains in value. On the flip side, if we are wrong or there is a collapse in SLW, we are only risking 8% of the invested capital in the absolute worse case scenario. We have built a fence around SLW and can use other options plays to help pay for the cost of the insurance and eliminate the initial at risk amount.
Thanks for the comment, and let me know if you if you have any further questions about the married put setup.
Silver Sky For Silver Wheaton [View article]
Yes, the mining companies are corporations and must deal with the issues you outlined, as does any corporation. We agree with you that the mining ETFs are a less volatile and perhaps more conservative way to track the metal prices, but investing in the mining stocks with this setup gives us the opportunity to perhaps generate more income and reduce the initial at risk.
As the more volatile mining stocks, such as SLW, fluctuate in price we can use 11 different adjustments following the RadioActive Trading techniques to generate income, lower the initial at risk and potentially cancel all of that risk while still leaving the upside open. If we are wrong and the stock collapses, we are comforted knowing we are only risking 8% of our entire investment.
Here's to continued 'calm seas and clear skies' for your portfolio, and to the rum never being gone.
Trading Plan: Exit Strategies For Bull Put Credit Spreads [View article]
You are correct, in fact we strongly advocate that you should never enter a naked put, bull put or bear put debit spread unless one was prepared to own the stock. In the first part of this article we reviewed some of the recent bullish components of PCLN. Due to the high stock price of PCLN we discussed the potential of this leveraged bull put credit spread to take advantage of the bullish sentiment without putting up the large amount of capital to purchase shares of stock or sell a naked put.
But your point is indeed essential as we must be aware of the possibility of being assigned early on the short put and thus having to fulfill our obligation to buy shares of stock at the 600 strike.
Trading Plan: Exit Strategies For Bull Put Credit Spreads [View article]
In the article we did mention that 'these are some basic adjustments that may be considered' for the spread position. We wanted to keep the discussion simple and basic as you mentioned, and perhaps follow up at a later time with a discussion of the Greeks for various spreads.
Over the years I have found it easier and more successful to manage short term spreads based on the values discussed, though management techniques for diagonal and horizontal time spreads, as well as mult-leg spreads greater than two legs, require a more intense view of the Greeks for trade entry and adjustment.
Thank you again for your comment and feed back!
Trading Plan: Exit Strategies For Bull Put Credit Spreads [View article]
I personally have not used other Greek values for managing a spread. However, if we see a shift in implied volatility from one day to the next we may have to re-evaluate the underlying and the spread position if new concerns have emerged while we are in the trade.
Have you used other Greek values for your spread adjustments?