Lesson 14 of 25 · 6 min
What the put costs, expressed as an annual drag
A premium quoted in dollars per share becomes a rate the moment you divide it by price and by time.
A premium of $5.20 per share is an unusable number. Converted to a rate per year it becomes comparable to every other rate in a pledged account, including the one on the line itself.
annual drag = (premium ÷ share price) × (365 ÷ days to expiry)
- annual drag
- The premium restated as a percentage of position value per year.
- premium
- The option's cost per share.
- share price
- The current price of the shares being floored.
- days to expiry
- Calendar days the contract covers. Dividing 365 by it converts the period's cost to a yearly rate, so a shorter contract annualises to a larger one.
The put from lesson 13 cost $5.20 against an $88 price for 219 days. As a fraction of price that is 5.20 ÷ 88 = 5.909 percent. Annualising multiplies by 365 ÷ 219 = 1.6667, giving 9.85 percent per year. Against an illustrative 7.4 percent rate on the line, the floor costs more per year than the borrowing it sits alongside.
Moving the strike changes the rate sharply. A put struck at $83.60, which is 95 percent of the price rather than 87.5 percent, might cost $8.90: that is 8.90 ÷ 88 = 10.114 percent, annualising to 16.86 percent. The higher floor removes more of the downside and costs 7 points a year more. Both figures describe the same shares.
One more property: the drag repeats. A nine-month contract covers nine months, so maintaining a floor for a longer period means buying another one at whatever it then costs. Three consecutive 219-day puts at $78,000 each total $234,000 against a $1,320,000 position, which is 17.7 percent of the starting value spent over about 1.8 years.
Key terms
- Annual drag
- An option premium restated as a percentage of position value per year, so it can be compared with an interest rate.
- Strike distance
- How far the floor sits below the current price. A closer floor costs more and removes more of the decline.
- Roll cost
- What it costs to replace an expiring contract with a new one. It is unknown in advance, because it is priced at the time.
Worked example
Two floors on the same shares, as annual rates
Shares at $88, 219 days to expiry. Put A struck at $77 costs $5.20; put B struck at $83.60 costs $8.90. Illustrative prices.
- Put A as a fraction of price
- 5.909%
- Annualisation factor
- 1.6667
- Put A annual drag
- 9.85%
- Put B as a fraction of price
- 10.114%
- Put B annual drag
- 16.86%
- Three consecutive A contracts on 15,000 shares
- $234,000
5.20 ÷ 88.
365 ÷ 219.
8.90 ÷ 88.
17.7% of a $1,320,000 position over about 1.8 years.
Raising the floor by 7.5 percent of the share price cost 7 points more per year. Both floors are real; the rates are what differ.
Check yourself
A put costs $3.75 per share on a $60 share price and expires in 146 days. What is the annual drag?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.