The combination of long stock and an equal ratio of long puts is a great marriage of sorts for bulls. In fact, it’s why option traders refer to the combination as a married put. But if the underlying asset is a death til you part sort of holding, the long puts which allow the position its protective qualities will need to be maintained by rolling contract months and often enough to different strikes.

But what if a married put in need of this type adjustment or a fresh starter position being considered, doesn’t offer the right strikes which satisfy this purpose? Then it could be time to make a slightly “kinky” union of sorts with the strikes offered, in order to make a more suitable marriage for the underlying shares.

To illustrate, let’s first take a simple position to get through the math more easily and then move onto a slightly more difficult situation. Let’s say a trader owns 200 shares of the venerable XYZ Corp with 2 puts that are all but worthless heading into expiration with a market showing no bid and offered at $0.05. Looking out into the next contract month and shares at 32.50, the trader is confronted with the fact the only near-the-money puts are on the 30 and 35 strikes.

Wishing to have the risk controlled by an at-the-money 32.5 when none is available, the trader in this situation can purchase one contract each of the surrounding money 30 and 35s to enjoy the equivalent benefits of a listed 32.5 put. Simple addition reveals this to be true as 30 + 35 / 2 = 32.5. And if the cost to purchase both contracts is $0.25 for the out-of-the-money and $2.75 for the in-the-money, the average cost for the two put position is $2.75 + $0.25 = $3.00 / 2 = $1.50.

In buying the two surrounding money puts the trader has manufactured his or her own at-the-money 32.5 married put for $1.50 with total risk of $300 for the two lot position, but the max risk is only realized at or below the lower 30 put. In that respect, it’s similar to a regular married put with its max risk drawn at its lone protective put.

To work out the upside breakeven, the trader needs to calculate the extrinsic value of each contract and add that cost to the stock price. In this instance, the math works out to $32.50 (current stock) + $0.25 (35 put extrinsic) + $0.25 (30 Put premium) = $33 for a breakeven.  

Now, what if we have a less simple situation due to stock or strike positioning? While the math is a bit more tedious, the work is nonetheless very much the same. For instance, let’s say our trader has 300 shares in XYZ which are in need of a protective hedge. Along with the odd but round lot of shares, the stock is positioned at 34 with the 30 and 35 puts still the only game in town for a married put strategy.

Figure 1: Manufactured Strike Position

By shifting the extra or third contract so two rest on the 30 strike and one on the 35, the trader can assemble a 31.66 strike put (30 + 30 + 35 / 3). Similarly but if they wish to have a bit more protection and don’t mind paying for that right, a 33.33 strike can be designed by purchasing two 35 puts and one 30 put. What’s something like this going to look like and cost the trader?

In the former and looser case using the further out-of-the-money, manufactured 31.66 put, the trader is risking $700 on 300 shares ((34 – 31.66) x 300) down to the averaged and maybe slightly devious strike. If we were to assign a cost of $0.10 per contract for the two 30s and $1.60 for the in-the-money 35 put, adding the combined debit of $180 means $880 is at risk. This is illustrated in Figure 1 shown above.

Again, this maximum loss is realized below the lower utilized 30 strike and not the worked out 31.66, which we use to figure the overall risk, while our two active partner strikes display the actual kinky marriage on the risk graph. Once more, for the breakeven we look at both contract’s extrinsic value and add this to the share price. Here however, the premium found for the in-the-money contract is divided by the remaining contract size used to purchase the lower put, then added to the out-of-money strike premium.

In our example, the $0.60 of extrinsic value from the 35 put is divided by two for a figure of $0.30. This is added to the 30’s $0.10, whose combined $0.40 is added to the $34 cost of stock to produce a breakeven of $34.40. Now that’s some complicated if not kinky business, but given the right circumstances, it could be protected play worth entertaining for bulls.

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site
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The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.