What is a long put option strategy?
A long put is a bearish trade where you buy one put option and profit if the stock falls below the strike price minus the premium you paid. The maximum loss is the premium. The maximum profit is large but capped, because a stock cannot fall below zero: it equals the strike price minus the premium, per share. Breakeven at expiration is the strike price minus the premium. It is one of the simplest options strategies and a common starting point for beginners.
Compared with short selling, a long put caps your loss at the premium, while a short sale has unlimited loss if the stock rises. However, there are certain things you should keep in mind to make the most out of options trading as a whole. The premium and implied volatility drive the result. Out-of-the-money puts cost less but need a bigger drop to pay off. Buying when implied volatility is already high makes the put expensive, while a rise in implied volatility after you buy increases the put's value.
I will explain the strategy with the help of an excel template provided by marketXLS and discuss the possible scenarios.
Tracking a long put with MarketXLS
MarketXLS is an add-in for Microsoft Excel that pulls stock and options data into a spreadsheet (real-time on the Advanced and Business plans, delayed or end-of-day on Standard). Apart from this, it also provides templates to manage and track Long Put options trades for different strategies. Here, I have used Microsoft(MSFT) options as an example. This trade is not taken in real, and it is just for explaining. As I am writing this article, the MSFT shares are trading at $239. Let’s assume that the trend will be bearish in the next couple of days. Therefore, we bought a put option at $230, which will expire on 5-Feb-2021. The premium paid for one contract (100 shares) at $2 per share is $200.
Profit, loss, breakeven
We have bought an out of the money contract (100 shares) of MSFT with a strike price of $230 at a premium of $2. Let’s have a look at the possible scenarios:
1. Let’s say my assumption was right, and the stock moved down, say to $225. The intrinsic profit would be that is $500 and the net profit would be
that is $300. The profits will keep increasing with the stock moving downward.
2. If the stock moves in the other direction or doesn’t move, the contract will be deemed worthless, and my net loss would be the premium that is $200. This is the maximum loss I am going to make in this trade.
The breakeven point would be $228.
Profit grows as MSFT falls below $228, up to a maximum of $22,800 if the stock went to zero. The loss is limited to $200 if the stock finishes at or above the $230 strike.
The bottom line
To end the article, long-put is a beginner level strategy. The capital required will vary with the profit expectations. But the foremost driving force in this strategy would be the Volatility of a particular underlying. The loss is limited to the premium, which is the main advantage over short selling the stock. This article is educational, not investment advice.
Disclaimer
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The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein.
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References
Learn more about long put OptionsTrading.org long-put guide.
