Long Put

The long put option strategy is a basic strategy in options trading where the investor buy put options with the belief that the price of the underlying security will go significantly below the striking price before the expiration date.

Long Put Construction
Buy 1 ATM Put

Put Buying vs. Short Selling

Compared to short selling the stock, it is more convenient to bet against a stock by purchasing put options as the investor does not have to borrow the stock to short. Additionally, the risk is capped to the premium paid for the put options, as opposed to unlimited risk when short selling the underlying stock outright.

However, put options have a limited lifespan. If the underlying stock price does not move below the strike price before the option expiration date, the put option will expire worthless.

"Unlimited" Potential

Since stock price in theory can reach zero at expiration date, the maximum profit possible when using the long put strategy is only limited to the striking price of the purchased put less the price paid for the option.

The formula for calculating profit is given below:

  • Maximum Profit = Unlimited
  • Profit Achieved When Price of Underlying = 0
  • Profit = Strike Price of Long Put - Premium Paid
Long Put Payoff Diagram
Graph showing the expected profit or loss for the long put option strategy in relation to the market price of the underlying security on option expiration date.

Limited Risk

Risk for implementing the long put strategy is limited to the price paid for the put option no matter how high the stock price is trading on expiration date.

The formula for calculating maximum loss is given below:

  • Max Loss = Premium Paid + Commissions Paid
  • Max Loss Occurs When Price of Underlying >= Strike Price of Long Put

Breakeven Point(s)

The underlier price at which break-even is achieved for the long put position can be calculated using the following formula.

  • Breakeven Point = Strike Price of Long Put - Premium Paid

Example

Suppose the stock of XYZ company is trading at $40. A put option contract with a strike price of $40 expiring in a month's time is being priced at $2. You believe that XYZ stock will fall sharply in the coming weeks and so you paid $200 to purchase a single $40 XYZ put option covering 100 shares.

Say you were proven right and the price of XYZ stock crashes to $30 at option expiration date. With underlying stock price now at $30, your put option will now be in-the-money with an intrinsic value of $1000 and you can sell it for that much. Since you had paid $200 to purchase the put option, your net profit for the entire trade is therefore $800.

However, if you were wrong in your assessement and the stock price had instead rallied to $50, your put option will expire worthless and your total loss will be the $200 that you paid to purchase the option.

Note: While we have covered the use of this strategy with reference to stock options, the long put is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

Similar Strategies

The following strategies are similar to the long put in that they are also bearish strategies that have unlimited profit potential and limited risk.

Put Backspread
Protective Call

Out-of-the-money Puts

Going long on out-of-the-money puts maybe cheaper but the put options have higher risk of expiring worthless.

In-the-money Puts

In-the-money puts are more expensive than out-of-the-money puts but the amount paid for the time value of the option is also lower.

Ready to Start Trading?

Open an account at OptionsHouse.com and get 100 commission-free trades + free virtual trading tool!

Your new trading account is immediately funded with $5,000 of virtual money which you can use to test out your trading strategies using OptionHouse's virtual trading platform without risking hard-earned money.

Once you start trading for real, your first 100 trades will be commission-free! (Make sure you click thru the link below and quote the promo code '60FREE' during sign-up)

Click here to open a trading account at OptionsHouse.com now!

Continue Reading...

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

From Around The Web



Follow Us on Facebook to Get Daily Strategies & Tips!



You May Also Like



Bearish Strategies

Options Strategies

Options Strategy Finder

Outlook on Underlying:


Profit Potential:


Loss Potential:


Credit/Debit:


No. Legs:





Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2016. TheOptionsGuide.com - All Rights Reserved.