Josip Causic

Buying Insurance on Your Stocks

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This article originally appeared on The Options Insider Web site.

In many of my classes, as I go through various option strategies, a question frequently pops up about the married put. The majority of our students are unfamiliar with the intricacies of the married put. Here I am going to explain, in a simple and easily understandable way, what a married put is.

In one sentence: A trader is long 100 shares and also long a single put contract.

Buying 100 shares could be done with or without buying a put, so let me give both scenarios.

Scenario Without Options

If an equity trader is holding a bullish outlook on a product that is currently trading at $40 per share, then the trader could simply proceed with the outright purchase of the underlying product.

In such case, the trader does not have any protection from downside risk, with the exception of the trader's stop-loss. Whenever the product decides to move up, the trader will be profitable. And if the trade does not move up, then the trade might get taken out on the HARD stop-loss.

The reason why I emphasize the word "hard" is because a lot of traders only use a "mental" stop-loss. It exists only in their heads and it has not been mechanically entered. Hard stop-losses are mechanically entered on the trading platform and are, by default, good for only 90 days.

In my classes, I always explain the fact that GTC does not truly mean good till cancelled, but good for only 90 days.

At any rate, if the trader enters a mechanical stop-loss, then that is the only protection that he or she has against the product not moving in his or her favor. Is there any other solution to elevated risk from the downside? Yes, and it is called a married put.

Scenario with Options: The Married Put

If the same trader is feeling bullish on a stock but he or she does not want to assume a big risk, then the trader could use put options for protection. In such case, the trader would buy 100 shares of the underlying at its current price, for instance at $40, and as soon as he or she got filled on the order, the trader could also buy a single put option contract for protection from the downside risk.

Specifically, the trader could purchase an ATM (at the money) put, which would have a strike price of $40 and expiry of, let's say 90 days out. The moment he or she gets filled, the position is somewhat delta neutral, because the trader is long 100 shares and he or she is also long a single put contract, which also controls 100 shares; being long 100 shares gives a delta of 100, and being long a put gives a negatively correlated delta.

Let's assume that, technically speaking, he or she is in an exactly delta neutral position for the positive and negatively correlated delta should cancel each other out. (By the way, the truth of the matter is that the ATM put always has a -0.50 delta, yet for the purpose of the educational discussion that I have in mind, we will close our eyes temporarily to this truth.)

The trader, long 100 shares and also long a single ATM put, knows that he or she has a hedged position on; so let us see two possible scenarios.