Option Strategy: Long Put

Long put options strategies are an ideal tool for investors who want to profit from downward movement in the underlying stock price. Investors should thoroughly understand the basic concepts of buying and holding put options before venturing into more complex bear market strategies.

When to use?

Buying put options without owning the underlying stock is a pure one-way strategy used for bear market speculation. The basic motivation of an investor using this strategy is to profit from a decline in the price of the underlying security. Such an investor is usually more interested in the amount of his initial investment and the skewed financial return that the long put option brings than the number of contracts purchased.

Experience and accuracy are key to choosing the right options (in terms of expiration date and/or strike price) to achieve maximum profit. Generally speaking, the more put options purchased that go out-of-the-money, the more bearish the strategy is. This is because the price of the underlying stock needs to fall more in order for the option to reach the break-even point.

benefit?

A long put option is a tilted option to sell bearishly, also known as a “short sale,” of the underlying stock. It also offers investors less potential risk. As with a long call option, an investor who buys and holds a long put option has a predetermined, limited financial risk. In contrast, shorting a stock has an unlimited, capped risk. The initial capital investment required to purchase a put option is less than the margin required to establish a short stock position. Regardless of market conditions, a long put option never results in a margin call. Adding leverage can yield a greater percentage of profit when the contract becomes more profitable.

Risks and benefits?

Maximum Profit: When the stock price drops to zero, the profit reaches its upper limit.

Maximum loss: Limited (premium paid)

Cap profit at expiration: Strike price – Stock price at expiration – Premium paid (assuming stock price is below breakeven point.)

Because the stock price can never fall below zero, the maximum profit is limited by this. At expiration, a put option that is in the money usually has intrinsic value. Although the potential loss is predetermined and limited, it could be 100% of the premium paid for the put option. Whatever your motivation for buying a put option, weigh the potential gain against the possible loss of the entire premium.

Break-even point?

Break-even point: Strike price – Premium paid

However, before the expiration date, if there is enough time value remaining in the market price of the contract, the break-even point will be higher than this price.

Volatility?

If volatility increases: positive effect If volatility decreases: negative effect

The impact of volatility on the total premium of an option is in the time value portion.

Time weakening?

The Passage of Time: Negative Effects

The time value portion of the option premium that the option holder “purchases” when buying the option generally decreases, or weakens, over time. This decrease accelerates as the option contract approaches expiration. Market observers will notice that put options time-weaken at a slower rate than call options.

What are the other options before the expiration date?

At any time before the expiration date, the put option holder can sell the put option in the listed options market to close the position. This can earn a profit on the option premium or reduce losses.

What are the other options at the expiry date?

At expiration, most investors holding put options that are in the money will choose to sell the option in the market before the close of trading on the option’s last trading day. Another option is to buy a significant amount of stock in the market, exercise the long put option, and then sell it to the put writer at the option’s strike price. A third, more risky option is to exercise the put option and sell the underlying stock to establish a short stock position in a proper economic account.