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Traders who implement a long put strategy are betting that the market price of an option's underlying asset will fall significantly. The technique involves buying one or more put option. If things go wrong and the market price of the underlying asset rallies, the trader's loss-risk is limited. Unlike short selling, put buying does not limit an investor's potential profit. However, a trader does run the risk of the asset expiring worthless, if the option's strike price remains above its breakeven point.

 

Moneyness Review for Puts

 

Out-of-The Money (OTM) = Strike Price (less than) Market Price

In-The-Money (ITM) = Strike Price (more than) Market Price

At-The-Money (ATM) Strike Price (equals) Market Price

 

How to Carry Out a Long Put Strategy

 

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Disney stock is worth $40 (market price) in June.

1) Trader buys the put option: DISJul40($2)

- 100 shares of Disney stock

- Strike Price $40, at-the-money (ATM), expiring in 30 days

- Premium Cost of $2

2) Trader pays a total of $200 to enter the market [$200 (paid to purchase one put option)]

Total cost to enter the market: $200

 

Result one: Disney stock falls (crashes) to $30

a) The put option bought is ITM.

b) The trader buys 100 Disney shares in the open market for $3000.

c) The trader exercises his or her right to sell 100 shares at $40 to the investor who wrote the put option. The trader sells 100 Disney shares and receives $4000 from the writer.

d) The trader makes a total profit of $800 after subtracting the costs to enter the market. [$800 = $4000 (received for 100 shares) - $3000 (paid for 100 shares) - $200 (cost to enter market)]

 

Result two: Disney stock rises (rallies) to $50

a) The put option bought expires worthless (OTM)

b) Trader loses a total of $200 after adding the amount paid to enter the market.

 

Result three: Disney stock falls (moderately) to $38

a) The put option bought is ITM.

b) The trader buys 100 Disney shares in the open market for $3800.

c) The trader exercises his or her right to sell 100 shares at $40 to the investor who wrote the put option. The trader sells 100 Disney shares and receives $4000 from the writer.

d) The trader makes a total profit of $0 after subtracting the costs to enter the market. Thus, $38 would serve as the break even point in this example. [$0 = $4000 (received for 100 shares) - $3800 (paid for 100 shares) - $200 (cost to enter market)]

 

Advantages and Disadvantages of Carrying Out a Long Put:

 

Pluses: The upside of this type of strategy is that the investor can gain unlimited profits with limited risk. The trader knows exactly how much he or she can lose before carrying out a long put strategy. He or she also knows the strategy's breakeven point when entering the market, which is the put option's strike price subtracted from the total cost to enter the market.

 

Minuses: The downside of using a long put strategy is that the method has a time limit to realize profits. Most put options expire in thirty days. Thus, the market value of the put option's underlying asset must fall below the strategy's breakeven point within this time limit or the option will expire worthless.

long-put.gif.90f7c923b148c066802ce0444d2d3d33.gif

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