A long put, alternatively known as a put option purchase, is a trading strategy where an investor acquires a put option with the expectation that the underlying asset's price will decrease.
This approach is commonly utilized in bearish markets or when a trader anticipates a significant downward movement in a specific stock or asset. When implementing the long put strategy, the trader pays a premium upfront for the right, though not the obligation, to sell the asset at the predetermined strike price before the option reaches its expiration date. This gives the trader the potential to profit from a decline in the asset's value, making the long put strategy a suitable choice when bearish market conditions are anticipated.
BEARISH OUTLOOK
A long put strategy is employed when an investor is bearish on the underlying asset.
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The goal is to profit from a decline in the asset's price.
LIMITED PROFIT POTENTIAL
The maximum loss for the investor is limited to the premium paid for the put option.
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However, the profit potential is theoretically unlimited if the underlying asset's price drops substantially.
NO OBLIGATION TO EXERCISE
There is no obligation to exercise a long put option.
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In a long put strategy, the investor has the right but not the obligation to sell the underlying asset at the specified strike price before or at the option's expiration date.
PROS | CONS |
Profit from Downward Movement: The primary advantage of a long put strategy is the potential for significant profits if the price of the underlying asset declines. The put option gives the investor the right to sell the asset at a specified strike price, which can result in a profit if the market price falls below that level. | Limited Profit Potential: While a long put strategy offers the potential for significant profits if the underlying asset's price drops, the maximum gain is capped at the difference between the strike price and zero if the asset becomes worthless. This limits the profit potential compared to other more aggressive strategies. |
Limited Risk: Unlike short selling, where losses can be theoretically unlimited, the risk in a long put strategy is limited to the premium paid for the put option. This makes it a defined-risk strategy, providing a level of downside protection. | Time Decay: Options contracts lose value over time due to time decay. If the anticipated price movement doesn't occur within the specified timeframe, the value of the put option may decline, even if the underlying asset eventually moves in the desired direction. |
Volatility Risk: Changes in implied volatility can impact the value of the put option. If volatility decreases, the option's premium may decline, affecting potential profits. Conversely, an increase in volatility can be beneficial for the long put strategy. | |
Potential Loss of Premium: If the price of the underlying asset remains above the strike price of the put option at expiration, the investor may lose the entire premium paid for the option. This is the maximum loss in this strategy. |
LONG PUT AND OPTION ASSIGNMENT
The buyer (holder) of a long put option is not exposed to assignment risk.
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Assignment risk pertains to the potential obligation faced by the option seller (writer) to fulfill their contractual duties.
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In the case of a long put strategy, the buyer maintains control over the decision to exercise the option, eliminating the risk of being assigned the obligation to purchase the underlying asset.
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Assignment risk is a more pertinent consideration for option sellers, particularly in strategies like covered calls, where investors sell call options against an existing long stock position.
LONG PUT EXAMPLE
Suppose an investor holds a bearish view on the SPDR Dow Jones Industrial Average ETF Trust (DIA) for the upcoming nine days. Envisioning the stock's current trade at $347.47 per share, the strategy chosen to express this bearish outlook involves the execution of a long put strategy. In this scenario:
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Buys for $2.46 one put option with a strike of $350 expiring in nine days
This strategic move results in a net debit of $2.46 for the single option, derived from the purchase of the $2.46 debit. Considering the standard equivalence of one options contract to 100 shares of the underlying asset, the overall debit accumulated stands at $246.
MAXIMUM PROFIT SCENARIO
Suppose DIA experiences an downtrend, reaching $347.54 or below at the time of expiry. This results in the attainment of a potential profit, amounting to an limited amount of $34,754. The formula calculates the profit by taking the difference between the strike price of the put option and zero (since the underlying asset's price cannot go below zero), multiplying it by 100 (since options contracts typically represent 100 shares of the underlying asset), and then subtracting the total premium paid for the put option.
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((Long Strike - 0) * 100)) - Total Premium paid
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(($350 - 0) * 100)) - $246 = $34,754
It's important to note that once the stock surpasses the strike price, the strategy continues, and the limited profit of $34,754 will continue to accrue beyond this point.
MAXIMUM LOSS SCENARIO
Should the DIA shares hover at $350 or rise above the designated strike, the maximum loss comes into play. Yet, this loss will plateau at the cost of the strike until the position is closed and then multiplied by 100 shares.
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Capped Potential Loss
The investor's undesirable scenario envisions the stock concluding above the $350 per share mark upon expiration, thus marking the potential loss for this investor of a capped loss of $246.
BREAKEVEN POINT
For a long put, the breakeven point is calculated by subtracting the strike price miinus the net premium paid.
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Strike Price: $350
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Net Premium Paid: $2.46
At expiration, for the strategy to be profitable, DIA must be below $347.54. If DIA is exactly at $347.54, the investor breaks even. Below $347.54, the investor starts to profit. Above $347.54, the investor incurs a loss, with the maximum loss being capped at $246 if DIA is at or above $350.
The long put strategy presents a robust approach for investors expecting a decline in an asset's price, allowing them to potentially profit from such movements. Unlike other strategies, it offers defined risk with unlimited profit potential if the underlying asset's value drops significantly. This makes it a favored choice in bearish market conditions, where investors seek to capitalize on downward trends without being obligated to sell the asset. Mastering the long put strategy can provide a strategic advantage by leveraging market pessimism effectively.
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- Long Put - Speculative www.fidelity.com/learning-center/investment-products/options/options-strategy-guide/longput-speculative.
- Long Put, OIC, www.optionseducation.org/strategies/all-strategies/long-put.
- Explaining Put Options (Short and Long) - CME Groupwww.cmegroup.com/education/courses/introduction-to-options/explaining-put-options-short-and-long.html.
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