What is Long Put?
Long put can be defined as a strategy that is used in options trading by the investors while purchasing a put option with a common belief that the price of a particular security shall go lower than its striking price prior to or at the time the arrival of the date of expiry.
Below is the payoff diagram in case of the Long put option. In the diagram, it can be observed that in case the price of the underlying asset is higher than the strike price of the option, then put option holder is in the situation of the loss and it will lose its money but the same will be equivalent and restricted to the amount of the premium paid by the holder for such option.
Now, if the price of the underlying asset decreases continuously from the strike price, then the loss of the holder will decrease until the time value of the underlying asset reaches the breakeven point. After reaching the breakeven point, if the price of the underlying asset continues to decrease, then there will be profit for the holder of the put option.
Characteristics
- Decay Characteristics: As per this characteristic, more the time passes, the value of the position will decline when the same moves towards the expiration value.
- Loss Characteristics: This is an options trading strategy states that the loss is limited to the amount that is paid for the option in form of the premium. If the market ends over the strike price, then there will be a loss.
- Profit Characteristics: In this strategy, the price has an inversely proportional relationship with the market. In other words, if the market falls, profits are going to increase and vice-versa. At the expiration date, the break-even point will be the amount of premium paid for the option. Profit tends to increase by the extra amount for each and every amount decreases below the break-even point.
Long Put Trading Strategy
- When the investor expects the market to be in the bearish state then the strategy that can be used in order to make the profit is the Long Put strategy. This strategy is opposite to that of the Long Call strategy which is suitable when the investor expects the market to be in the bullish state. In the case of this trading strategy, the investor tries to hold the position where it could be benefited from the decrease in the underlying asset’s price. This strategy gives the right of selling the underlying asset to the buyer of the option where the amount of risk involved is limited to the amount of premium paid for buying the option while rewards that could be earned are unlimited.
- This is similar to that of the short-selling of stock but the strategy of a long put may be favorable over short selling because the amount of risk involved is limited to the amount of premium paid includes with lower investment. However, there prevails some challenges like it has an expiry date so the same cannot be held for an indefinite time like the stock.
Example of Long put
Shares of the company ABC is trading in the market $100. There is an investor who is having $300 with him, expecting the bearish trend in the market and 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 investors invest his $300 for purchasing the 1 put option contract. Now, the price of the stock falls to $80 by expiration, and the price of the put option increases to $6 per share.
Calculate the profit / loss of the investor.
Solution:
Total Amount invested by investor = $300
- = $6 * 100
- The total price of the put options at the time of expiration = $600
- Profit = $600 -$300
- Profit = $300
When to Use?
An investor must exercise a long put option strategy when he or she has a bearish outlook and is expecting an underlying asset’s value to significantly drop in the nearing time. Investors can also use this strategy for hedging purposes if he or she is seeking to safeguard an underlying asset that is owned against a probable reduction in its value.
Difference Between Long Put and Short Put
- Market View: The market view in the case of the long put is bearish while in the case of a short put is bullish.
- Risk profile: The risk profile in the case of the long put is limited while in the case of a short put is unlimited.
- Reward profile: The reward profile in the case of the long put is unlimited while in the case of a short put is limited.
- Action: The action in the case of the long put is “buy put option” while in the case of a short put is “sell put option”.
Benefits
- Limited Risks: This options is the fact that the risks in this option are limited to the extent the premium is paid towards the put option.
- Unlimited Profits: This is the fact that investors can earn unlimited profits using this option with defined risks.
Drawbacks
An investor is not provided any sort of protection if his or her underlying asset rises in price and he or she might incur full loss of premium amount if the price of his underlying asset rises as he or she will not be able to exercise this option.
Conclusion
Long Put strategy is good for investors who are expecting a significant fall in the price of an asset. It is a simple strategy and is ideal for new investors that offers limited risks and unlimited profits to investors.
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