A Guide to the Long Put Strategy: Basics You Need to Know
Long puts can be a useful options trading strategy employed by some traders seeking to capitalize on anticipated declines in an underlying asset's price. It involves purchasing put options with the expectation that the asset's value will fall below the option's strike price before expiration. Long puts can serve speculative purposes for possible profit enhancement through leverage or as protective hedges against existing long positions, making them a common component of an options trader's toolkit.
Read on to learn more.
What is a Long Put
A long put is an options trading strategy that gives an investor the right, not the obligation, to sell 100 shares (per option contract) of an underlying asset at the strike price on or before the expiration date. The price paid for the option is the premium. Investors can consider using long puts when they believe a security's price will decrease; it's considered a bearish strategy.
How a Long Put Strategy Works
What is a long put position? It involves buying a put option to potentially profit from a short-term price decline in a stock or market index. The buyer pays a premium to the options seller to get the right to sell the underlying asset at the strike price until the expiration date. This premium is the theoretical maximum potential loss if the long put expires worthless.
A trader can potentially profit if the put's price rises as the price of the underlying falls. Profit can be calculated as the difference between the put sell price (sell to close) and the put purchase price (buy to open) multiplied by the number of equivalent shares or units.
The Goal of a Long Put strategy
The goal of a long put strategy is to profit from a decline in the price of an underlying asset such as a stock or market index during a specific period of time (or pre-determined time period); this could be the expiration date. It may be appropriate for bearish investors looking to possibly benefit from an expected downturn without the risks and complications associated with short selling the stock, which can include potentially losing a lot of money, facing margin calls, and dealing with increasing borrowing costs.
The timeframe for this strategy is constrained to the duration of the option contract itself. Here's a deeper look into a long position in a put option.
Theoretical Maximum Profit
A long put can be profitable if the price of the underlying asset, like a stock, falls. The theoretical maximum profit potential for a long put is substantial. For example, if a long put option with a $100 strike price is purchased for $5, the max profit potential is substantial; however, at expiration, the underlying stock must be below $95 to see a profit.
Theoretical Maximum Risk
If the stock price is above the strike price at expiration, and the put owner still holds the position, the put option expires worthless and the loss is the price paid for the put. For example, if a long put option with a $100 strike price is purchased for $5, the theoretical maximum loss is $500 ($5 x$100).
Breakeven Stock Price
The break-even point for a long put option is calculated by subtracting the premium from the strike price. If a stock is currently trading at $100 and investor buys a put option with a $90 strike price at $5, the break-even price is $85. At expiration, the stock price must be below $85 for the investor to potentially make a profit.
Long Put Example
Let’s assume a stock is trading at $55. An investor buys 1 long put with a strike price of $50 at $3 ($3 x100 = $300 debit).
The theoretical maximum profit is the strike price x 100 (options multiplier) - the total paid debit.
For this example, it's $5,000 ($50 strike price x 100) - $300 = $4,700.
The theoretical maximum loss equals the debit paid or $300 and the breakeven point equals the strike price - the purchase price or $50 - $3 = $47.
How to Trade Long Puts Using Moomoo
Moomoo provides a user-friendly options trading platform. Here's a step-by-step guide to get you started:
Step 1: Navigate to your Watchlist, then select a stock's "Detailed Quotes" page.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 2: Navigate to Options> Chain located at the top of the page.
Step 3: By default, all options with a specific expiration date are shown. For selective viewing of calls or puts, simply tap "Call/Put."
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 4: Adjust the expiration date by choosing your preferred date from the menu.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 5: Easily distinguish between options: white denotes out-of-the-money, and blue indicates in-the-money. Swipe horizontally to access additional option details.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 6: Explore various trading strategies at the screen's bottom, offering flexibility for your investment approach.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Factors Affecting the Long Put
An investor buys long puts as they typically believe the underlying asset will decline. They may also buy a put to help manage risk as they think the underlying asset may decline, which will increase a long put option's value for hedging purposes. Whatever their reasons are for making this trade, different factors affect puts.
Underlying Price Change
A long put's value usually moves in the opposite direction of the underlying stock price. When the stock price increases, the long put's price decreases, resulting potentially in a loss. And when the stock price decreases, the long put's price increases, resulting in a potential profit.
However, put prices generally don't change dollar-for-dollar with changes in the underlying stock price. Instead, puts change price based on their "delta." For example, a long at-the-money put's delta is usually around -50%, so a -$1 decline in the stock price would cause the put to increase in value by .50 cents per share.
Volatility
Long puts can benefit from rising volatility as it can increase their value; they are also affected by declining volatility as it decreases their value. When volatility increases, the prices of all options on that underlying tend to rise, including long puts. This is because volatility indicates a greater probability that the stock will move enough to give the option intrinsic value by expiration day.
Time Decay
Time decay (also known as theta), can negatively impact long put options. Time decay is the process by which options lose value over time as the expiration date approaches. There is less time for the underlying asset to move, and the options become less valuable. This can affect long puts if other factors remain the same.
Other Factors
Additional factors to consider include expiration risk. At expiration, if the option is in-the-money, a brokerage firm may exercise it on an investor's behalf. Dividends are another factor. On the ex-dividend date, the dividend's amount is deducted from the underlying stock's value. If there's no other changes, the put option's value is boosted from a lower stock value.
Potential Pros and Cons of the Long Put
Pros
Profit potential: If the underlying asset's price falls substantially below the strike price, the value of the put option can increase significantly. This can allow traders to capitalize on pronounced downward price movements.
Limited Risk: Unlike some other trading strategies, the theoretical maximum loss for a long put is limited to the premium paid for the option. This predefined risk can make long puts a useful hedge against the potential decline in value of a stock owned by the investor.
Leverage: Long puts provide leverage, as the cost of the option is typically a fraction of the cost of the equivalent position in the underlying asset. This means that traders can control a more significant position with a relatively small investment, potentially amplifying returns on successful trades.
Flexibility: Long put options can be used in various market conditions, offering flexibility and diverse strategic applications. Traders can utilize long puts for speculative purposes, anticipating a drop in the asset's price, or as a protective measure to hedge against potential losses in a long stock position.
Cons
Complexity: Trading long puts can be more complex compared to straightforward stock transactions. Successful execution can require a solid understanding of options strategy, Greek values, and market conditions, making it less suitable for novice traders without proper education or experience.
Time decay (Theta): As the option approaches its expiration date, its value can decrease even if the underlying asset moves in the anticipated direction. Traders need to be mindful of the option's timeframe to try to mitigate this erosion in value.
Upfront premium cost: Purchasing a long put requires paying an upfront premium. If the underlying asset does not move as expected or remains relatively stable, the premium paid can result in a total loss.
Volatility sensitivity (Vega): Vega quantifies how much an option's price is expected to change in response to fluctuations in the implied volatility of the underlying asset. For a long put, it has positive vega: when volatility increases, it typically increases in value but when volatility decreases, it also decreases in value.
Long Put vs Short Put
An investor can buy a long put option when they expect the price of an underlying asset to decline or become volatile in the near future. This strategy can be beneficial for bearish investors. The investor can profit if the option increases in value and is sold for more than its purchase price, or if it expires in the money.
A short put option (also known as a naked put) can be used when an investor believes an underlying asset's price will increase. This strategy is also associated with being bullish on the price of the asset. The investor can possibly profit from the option premium paid by the buyer at the start of the contract. However, short puts can be risky because the investor may be forced to buy shares if the market price drops significantly.
Long Put vs Short Call
What is a long put option? It gives the buyer the right, but not the obligation, to sell the underlying asset at a predetermined price (the strike price), on or before the option's expiration date. Their theoretical maximum loss is the premium paid for the option. Long puts are bearish strategies that can be profitable if the market drops; they generally require less upfront capital than a short stock position.
Short call is similar to short selling, but without borrowing stock. The seller receives a premium for taking on the short call position, and their potential profit is limited to the premium.
The max loss potential for a short call is unlimited. Therefore it can be a highly risky strategy when compared to a long put.
FAQs about Long Put Options Strategy
How do you calculate a potential profit/loss for a long put?
For potential maximum gain: Subtract the premium from the strike price
For potential maximum loss: Equal to the premium paid plus commissions
Break-even at expiration: The stock price is below the strike price by the cost (premium) of the long put option.
Value at expiration: Subtract the underlying stock price from the strike price
Potential profit at expiration: Subtract the option cost from the value at expiration, then multiply by the number of contracts and 100
How do you exit a long put?
A long put position can generally be exited at any time before expiration by entering a sell-to-close order. The contract can be sold at either the market or a limit price, and the premium collected will be credited to the account. If the contract is sold for more than the original purchase price, the trader will make a profit. If it's sold for less, they will incur a loss.