We all know that the majority of people don’t trade stocks, because they think that:
- Stock trading is a form of gambling
- Stock trading can be very risky
We, stock traders, laugh at the first point, because real stock trading doesn’t just consist of buying a stock and hoping that it’ll go up, it is about making your due diligence before buying the stock, and knowing that it will (most likely) go up, and if it goes down in the short term, then it’ll go up sometime in the future, and if it doesn’t, well, one should accept the loss gracefully and learn from it (incurring a loss is a possibility in any trade in any industry).
As for the second option, yes, stock trading can be risky, but the risk can be limited in many ways. One of these ways is called “married puts”. So what are they?
Let’s say you buy 1,000 shares of C at $42.70 (the current price). Your total cost will be $42,700. You know that Citigroup is bullish on the long term, but you can’t afford to lose a lot on the short term, if the stock goes considerably down. So you buy, at the same time of buying the C shares, “C Aug 2011 43.000 put” at $1.93/share for each share. Your total cost for the puts will be $1,930 (+broker commission). This means that each stock will now cost you around $44.63. But, on the flip side, you have protected your investment until August 19th. So, if the stock goes below $43, you will make money on the puts, if the stock goes above $44.63 you will make money on your stocks. Your loss per share (as long as you have the puts) is only the difference between $44.63 and $43, which is $1.63/share or around 4%. In other words, your total risk is no more than 4% for the next month, and we all know that it’s easy for any stock to move more than that 4% in any one day.
Now let me list both the advantages and disadvantages of married puts.
Advantages of married puts
- Minimal risk in stock trading
- Ability to make money both ways (in our case above, if the stock goes below $43 you will be making money on your puts, and if the stock goes above $44.63 you will be making money on your stocks)
- Peace of mind
Disadvantages of married puts
- Puts expire, and often you can’t get rid of them for a profit before they expire.
- Puts eat from your profits, as they typically increase the cost of a stock by 4% or 5% (depending, of course on the strike price and the expiry date of the put).
- Married puts add to the complexity of stock trading, now you have to take actions when the stock goes up and when the stock goes down.
- Married puts take all the thrill and excitement from stock trading.
Married puts are very convenient, but should be used wisely, and only when you don’t want to take any risk.
Note: This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.