An investor purchasing a put while at the same time purchasing an equivalent number
of shares of the underlying stock is establishing a "married put" position - a hedging
strategy with a name from an old IRS ruling.
Bullish to Very Bullish
The investor employing the married put strategy wants the benefits of stock ownership
(dividends, voting rights, etc.), but has concerns about unknown, near-term, downside
market risks. Purchasing puts with the purchase of shares of the underlying stock
is a directional and bullish strategy. The primary motivation of this investor is
to protect his shares of the underlying security from a decrease in market price.
He will generally purchase a number of put contracts equivalent to the number of
shares held.
While the married put investor retains all benefits of stock ownership, he has "insured"
his shares against an unacceptable decrease in value during the lifetime of the
put, and has a limited, predefined, downside market risk. The premium paid for the
put option is equivalent to the premium paid for an insurance policy. No matter
how much the underlying stock decreases in value during the option's lifetime, the
investor has a guaranteed selling price for the shares at the put's strike price.
If there is a sudden, significant decrease in the market price of the underlying
stock, a put owner has the luxury of time to react. Alternatively, a previously
entered stop loss limit order on the purchased shares might be triggered at a time
and at a price unacceptable to the investor. The put contract has conveyed to him
a guaranteed selling price, and control over when he chooses to sell his stock.
Maximum Profit: Unlimited
Maximum Loss: Limited
Stock Purchase Price - Strike Price + Premium Paid
Upside Profit at Expiration: Gains in underlying share value - Premium Paid
Your maximum profit depends only on the potential price increase of the underlying
security; in theory it is unlimited. When the put expires, if the underlying stock
closes at the price originally paid for the shares, the investor's loss would be
the entire premium paid for the put.
BEP: Stock Purchase Price + Premium Paid
If Volatility Increases: Positive Effect
If Volatility Decreases: Negative Effect
Any effect of volatility on the option's total premium is on the time value portion.
Passage of Time: Negative Effect
The time value portion of an option's premium, which the option holder has "purchased"
when paying for the option, generally decreases, or decays, with the passage of
time. This decrease accelerates as the option contract approaches expiration. A
market observer will notice that time decay for puts occurs at a slightly slower
rate than with calls.
An investor employing the married put can sell his stock at any time, and/or sell
his long put at any time before it expires. If the investor loses concern over a
possible decline in market value of his hedged underlying shares, the put option
may be sold if it has market value remaining.
If the put option expires with no value, no action need be taken; the investor will
retain his shares. If the option expires in-the-money, the investor can elect to
exercise his right to sell the underlying shares at the put's strike price. Alternatively
the investor may sell the put option, if it has market value, before the market
closes on the option's last trading day. The premium received from the long option's
sale will offset any financial loss from a decline in underlying share value.