Long put is one of the two strategies that involves buying or selling a put option. It is a simple strategy that is ideal for new investors, as it offers limited risks and unlimited profits.
Oftentimes, this trading strategy is used when the market is bearish, and the price of an underlying asset is expected to drop. The underlying asset here can be stock.
However, with these benefits comes a downside – Time. Put options don’t last forever. So if the stock price doesn’t fall as expected before the expiration date, the option becomes worthless and the investor loses his premium.
Hence, it is advised that you have basic understanding of the long put option and when to trade with it to ensure maximum profit.
This article explains in detail what the long put option strategy is, when the best time to employ this strategy is, as well as its benefits and disadvantages.
What is a Long Put?
Long put is a market strategy that involves buying a put option in anticipation that there will be a decline in the underlying asset.
The term “long” doesn’t necessarily mean that there is a long time before expiration. Rather, it describes the trader’s intention to sell the option at a higher price at a later point in time.
In addition, a trader could buy a “Put” for particular reasons, certain that the underlying asset will fall, which will then lead to an increase in value of his put option.
A long put option trader can either decide to sell before maturity to accumulate more gains, or hold it till maturity. When he must buy the underlying asset at the market price, and sell it at the strike price.
A long put strategy can also be used to secure a long position in the underlying asset. This means that if the underlying asset falls, the put option increases in value. Which in turn helps to offset the loss in the underlying.
In general, Investors go long put if they think a security’s price will fall. Tto limit the risks of the downside nature of the market.
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Basics of a Long Put Option
As we have established, a long put option is a trading strategy where a trader buys a put option in anticipation of the fall of the underlying asset before he can sell again.
Hence, a long put has a strike price. A strike price is a price at which the put buyer has the right to sell the underlying asset.
For example, let’s assume that the underlying asset is a stock price, worth $100. This means that the trader is allowed to sell the stock at $100 even if it drops to $50. But on the flip side, if the stock rises and stays above $100, the option becomes useless as it doesn’t make sense to sell at $100 when the stock is trading at $120.
So, if a trader wishes to use their right to sell the underlying asset at the strike price. They’d have to put in effect their full right to trade the option, also known as exercising the option.
An American option may be exercised before its expiration. However, in a European option, it can only be exercised at the expiration date.
The Long Put Trading Strategy
The long put strategy allows you to sell the underlying stock at the strike price. More so, puts are part of a trader’s advantage in the market.
Because, if there were no such things as puts, the only way to profit from the downward movement of the market is to sell the stock short. And this is a very risky trading strategy as it exposes you to lots of risks if the stock price increases.
This is why put option is a better alternative, as your risks are limited to the cost of the option agreement. If the stock price goes up ( which is the worst thing that can happen in a put option) you can allow your puts to expire worthlessly or sell off to close your position.
However, even if put options seem to be a better option. You have to be careful so as to not buy too many option contracts. Because doing so increases your risk as options may expire worthlessly and you can lose your entire investment.
On the flip side, puts can be used to protect the value of stocks you already own. They are known as “Protective Put”
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Long Put Strategy Vs. Short Stock Strategy
In a bear market, a long put may be a better strategy for investing than short selling their shares.
Theoretically, a short stock position has unlimited risk since the stock price has no capped upside. Also, it has unlimited profit potential since a stock cannot go below $0 per share.
While long put option on the other hand is similar to short stock as both strategies have unlimited profit potentials. A put option will only increase in value up to the underlying stock reaching zero.
However, the downside to this is that the price of the underlying asset must fall before the expiration date of the option otherwise the investor loses the amount he paid for the option.
Conversely, to profit from a short stock trade, a trader will have to sell back the stock at a particular price with hopes that he’d buy it back at a lower price.
Similar to put options, if the price of the underlying asset falls. Then the put option will increase in value and can be sold for a profit.
Example of Long Put Option
Here’s an example of a long-put trade option from Wall Street Mojo.
A company, ABC has shares trading in the market at $100. An investor who wants to invest with $300 is expecting the market to move in favor of the bear, thereby leading to a fall in the price of the shares of the company ABC.
At the money put of the stock of the company, ABC with the strike price of $100 is currently trading in the market at the rate of $3, and the contract of 1 put option consists of 100 shares.
So, the investor invests his $300 for purchasing the one-put option contract. Now, the price of the stock falls to $80 by expiration. The price of the put option increases to $6 per share.
Now to calculate the profit/loss of the investor,
Total amount invested by investor = $300
Total Price of the Put Options at the Time of Expiration = Put Option Price Per Share * Number of Shares
Hence, we have; $6 * 100
The total price of the put options at the time of expiration = $600
The profit of the investor is calculated as;
Profit = Total Price of the Put Options at the Time of Expiration – Total Amount Invested.
Profit = $600 -$300 = $300.
READ ALSO: BUYING A PUT OPTION: All you should know with examples
When to Use the Long Put Option
Long put trading strategy works best when an investor is expecting a bearish turn in the market, as well as the fall in price of an underlying asset.
Additionally, investors can use the long put option for hedging purposes. That is to say if he or she wants to safeguard an underlying asset that is owned against a possible reduction in its value.
Long Put vs Short Put
The long put and short put are options strategies that are used to describe the buying or selling of a put option.
According to Stock Investor, A put option is a contract between a buyer, who is known as the option holder, and a seller, who is known as the option writer.
This contract gives the holder the right, but not the obligation, to sell shares of an underlying security at a set price. The set price in an option contract is known as the strike price.
Put option contracts have expiration dates. Hence, options contracts must be exercised before the expiration date or the option becomes useless.
So, if an investor wants to execute the long put strategy, then he would buy a put option and become the option holder. A long put strategy is useful when there is an expected fall in the price of the stock.
If an investor wants to use the short put strategy, then he would buy a put option and become the option writer. A short put strategy is used when there is an expected increase in a stock price.
READ ALSO: SHORT PUT OPTION: Overview, Examples (+trading tips)
Examples
Below are examples of both the long and short-put strategies.
For a long put strategy, assume the stock of company ABC has a share price of $100. An investor then buys one call option for ABC with a strike price of $95 with an expiration date of one month. The investor expects the stock price to drop below $95 within the next month.
Now, as the put option holder, he has the right to sell 100 shares of ABC at a price of $95 until the expiration date. One option contract is equal to 100 shares of the underlying stock.
Let’s assume the premium for the put option costs $3 per share. Therefore, the holder pays $300 for the put option to the option writer. This amount is the maximum amount the holder can lose.
Assume the price of ABC falls to $90 in that month. This means that the holder can exercise the put option and sell it at $95 rather than $90. Additionally, he can buy shares of stock at the market price of $90 and sell at $95, having a profit of $5 per share.
However, if the stock price doesn’t fall below the strike price of $95 before the expiration date of the put option, the holder loses $300.
For a short put strategy, assume the stock of company ABC has a share price of $100. An investor then sells one call option for ABC with a strike price of $95 with an expiration date of one month. The investor expects the stock price to increase within the next month.
As the put writer, the investor receives a premium of $3 per share or a total of $300.
Now, let’s assume that the stock doesn’t close below $95. The option becomes worthless, and the option writer profits $300 because of the premium.
However, if the share price fell to $90 within one month, the option writer would have exercised the option. Would buy the stock at $95 instead of $90. This results to a loss of $5 per share.
In general, both a long and short put strategy are good trading strategies that can be used when the investor expects a fall or increase in the price of an underlying stock.
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Difference Between Long Put and Short Put
Below are the differences between the long put and short put options.
- Market View: In the long put, the market view is bearish while in the case of a short put, it is bullish.
- Action: In a long put option, the action about “buying a put option,” while for a short put, it is “selling a put option.”
- Reward profile: The long put option has an unlimited reward profile, while the short put option is limited.
- Risk level: The risk level of a long put is limited, while a short put is unlimited.
Benefits of the Long Put Option
The major benefit of the long put trading strategy is that is has a lower level of risk when compared to the short put option. The premiums are paid towards the put option.
Another benefit is that it offers unlimited profits. The fact that investors can earn lots of profits when the the market goes as expected, with a minimal level of risk makes this a good trading strategy.
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Cons of the Long Put Option
The disadvantages of trading with the long put option includes;
- Time is not your friend: For this strategy, time decay is a problem. This is because its benefits come when the stock price falls within the expiration date. After expiry, the put option becomes worthless.
- No protection: An investor doesn’t receive any kind of protection if his or her underlying asset rises in the price instead of the other way round.
How Do You Make Money on a Long Put?
The potential profit from long puts is limitless. To benefit from a long put option, it must be below its breakeven price when it expires. Subtract the contract premium from the option’s strike price to determine the break even point for a long put.
Does Long Put Mean Buy?
Long calls and long puts are the two different forms of long options. A long call option allows you to purchase, or “call,” shares of a certain stock at a predetermined price at a later time. In contrast, a long put option allows you to sell, or put, shares of that stock at a future date for a predetermined price.
What Happens When You Buy a Long Put?
The put buyer, in exchange for a premium, receives the right, but not the responsibility, to sell the underlying asset at the strike price at any time up until the expiration date. When investors purchase puts, they are betting that the price of the put will increase as the value of the underlying decreases.
How Are Long Puts Taxed?
If they held the contract for at least a year and a day, the seller of the LEAP is subject to tax at the long-term capital gain rate. Short-term capital gains rates would apply if they had held the contract for a shorter time frame.
When Should I Sell a Long Put?
If the stock price quickly declines, the owner of a long put has two options: either sell the contact before it expires for a profit. Short put positions, on the other hand, profit when the contract expires out-of-the-money (OTM) and is no longer worth anything; the profit is represented by the premium obtained for selling the contract in advance.
Do Long Puts Expire worthlessly?
100 short shares of stock at the strike price are created from 100 long puts. 100 long shares of stock at the strike price are created from 100 short puts. If an option expires out-of-the-money, it loses all of its value and is removed from the account.
Is a Long Put Spread Bearish?
Other names for the “bear put spread” exist. It is sometimes referred to as a “long put spread” and a “debt put spread.” The word “bear” refers to the strategy’s profitability when stock prices are bearish, or declining.
Conclusion
Long Put strategy is a good trading strategy for new investors seeking minimal risks and unlimited profit strategies.
More so, I hope this article explains what long put option really is to you.
All the best!
FAQs
When should I sell long put?
A long put gives you the right to sell the underlying stock at strike price A. … If the stock goes up (the worst-case scenario) you don’t have to deliver shares as you would with short stock. You simply allow your puts to expire worthlessly or sell them to close your position (if they’re still worth anything).
How can I make money with a long put?
When you buy a put option, you’re hoping that the price of the underlying stock falls. You make money with puts when the price of the option rises, or when you exercise the option to buy the stock at a price that’s below the strike price and then sell the stock in the open market, pocketing the difference.
How do puts make money?
A put option buyer makes a profit if the price falls below the strike price before the expiration. The exact amount of profit depends on the difference between the stock price and the option strike price at expiration or when the option position is closed.
