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This is a level 3 question.
What are married puts and when is the best time to use them?
A married put is simply the simultaneous purchase of stock and an equivalent number of puts to cover the shares. The put and the stock must be identified with each other, i.e., the stock is identified as the security that will be delivered upon exercise of the put. There have been tax advantages associated with married puts in that the put purchase is exempt from certain short-sale rules governing the holding periods of the underlying stock. Normally, a put bought to protect stock that has not been held long enough to be considered a long-term capital asset will wipe out the entire holding period of the stock. Thus, a put bought on a stock held for nine months, for example, will reset the holding period back to zero once the put is disposed of.
The married put, however, may be exempt from this restriction, but only if the investor delivers the married stock or allows the put to expire (in which case the cost of the put would be added to the cost basis of the stock). Selling the put and stock separately would remove this exemption. The married put strategy would not apply to stocks that already qualify for long-term capital treatment, as these holding periods are not affected by the put purchase in the first place. According to the CBOE website, the tax advantages of this strategy are still not clear, as the Treasury Department has not yet issued a final ruling on the matter.
Married puts (or protective puts in general) should be used to protect against the potential of the underlying stock to move lower. For example, buying a 40 put at 1 for a stock at 42 would limit the downside risk by allowing the investor to sell the shares at 40, no matter how low the stock price before expiration. For this example, the maximum loss for the position would be 3 and would occur at a stock price of 40 or less. At 40, the option would expire worthless (cost of 1) and the stock would have lost 2. At 35, the option is worth 4 (5 points in the money minus the cost of 1), while the loss on the stock is 7. On the upside, the breakeven for the trade is at a stock price of 43 (the original price of 42 plus the cost of the put). In essence, buying the put caps your downside risk and raises the breakeven point, while allowing unlimited potential on the upside.
One final word about married puts - always consult your tax advisor before investing in a potential tax-savings strategy. The rules governing married puts remain unclear at this point and it's best to seek the advice of a professional before proceeding.
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Question Level Key
Level One--Basic Jargon, Definitions, Basic Mechanics of Trading.
Level Two--Introductory Points, Practical Points and Simple Strategies
Level Three--More Advanced Strategies and Repairs
Level Four--Risk Management, Psychology, and How Best to Evaluate Things.
Level Five--High end questions concerning Portfolio Analysis, Managing a Portfolio
of Options, Option Pricing Models, and Nuances of Trading. Included could be a variety of
other topics.
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