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Long Put

Updated on April 29, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A 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 of the arrival of the date of expiry.

What Is A Long Put

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The option holder has the right and not the obligation to sell the asset at the strike price. If the price rises, the holder’s risk is limited to the premium amount. It is necessary to understand the concept clearly to trade in them after taking into account the market conditions.

Key Takeaways

  • A long put is an options strategy where an investor purchases a put option to profit from a decline in the underlying asset’s price.
  • With a long put, the investor has the right, but not the obligation, to sell the underlying asset at a predetermined price (strike price) within a specified period (expiration date).
  • The potential profit of a long put is significant if the underlying asset’s price decreases below the strike price.
  • Long puts can be used for speculative purposes to profit from downside moves in the market or as a form of portfolio protection against potential losses.

Long Put Explained

Long put option 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 offer limited risks and unlimited profits to investors.

In this process, the trader or the investor buys a put option with the anticipation that the price of the underlying asset will fall. Thus, the holder of the option gets a right, but not the obligation to sell the underlying asset at a particular price, known as the strike price, within a specified time period, known as the expiration date.

The main aim of this concept is to gain profit from fall in the price of the underlying asset. So, even when the price drops, the investor sells the asset at the strike price. In case the price rises, the loss is limited to the premium amount. However, it is subject to time decay, meaning, if the price of the asset does not fall within a short period, the option will lose its value.

Therefore, in this process of long put option the investor is not involved in directly adopting the short-selling strategy for the asset. It gives the opportunity to benefit from downward movement with limited risk. But it is important to understand the concept thoroughly and also take into consideration the market and economic conditions before engaging in such trades.

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Graph

Below is the long put payoff diagram in case of the option. In the long put graph, it can be observed that in case the price of the underlying assetUnderlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read more is higher than the strike priceStrike PriceExercise price or strike price refers to the price at which the underlying stock is purchased or sold by the persons trading in the options of calls & puts available in the derivative trading. Thus, the exercise price is a term used in the derivative market.read more 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 as explained in the long put graph above.

long put graph above

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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 optionPut OptionPut Option is a financial instrument that gives the buyer the right to sell the option anytime before the date of contract expiration at a pre-specified price called strike price. It protects the underlying asset from any downfall of the underlying asset anticipated.read more.

Startegies

Long Put Characteristics

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  1. Decay Strategy: As per this characteristic, the more time passes, the value of the position will decline when the same moves towards the expiration value.
  2. Loss Strategy: This is an options trading strategyOptions Trading StrategyOptions trading refers to a contract between the buyer and the seller, where the option holder bets on the future price of an underlying security or index.read more that states that the loss is limited to the amount that is paid for the option in the form of the premium. If the market ends over the strike price, then there will be a loss.
  3. Profit Strategy: 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 even will be the amount of premium paid for the option. The long put payoff tends to increase by the extra amount for each, and every amount decreases below the breakeven even point.

Long Put Trading Strategy

Example

Let us try to understand the concept with the help of an example.

Shares of the company ABC are trading at $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 out 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 one 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

Total Price of the Put Options at the Time of Expiration = Put Option Price Per Share * Number of Shares
  • = $6 * 100
  • The total price of the put options at the time of expiration = $600
Profit = Total Price of the Put Options at the Time of Expiration – Total Amount Invested
  • Profit = $600 -$300
  • Profit = $300

When To Use?

An investor must exercise a long put chart option strategy when he or she has a bearish outlook and is expecting an underlying asset’s value to drop in the nearing time significantly. Investors can also use this strategy for hedgingHedgingHedging is a type of investment that works like insurance and protects you from any financial losses. Hedging is achieved by taking the opposing position in the market.read more purposes if he or she is seeking to safeguard an underlying asset that is owned against a probable reduction in its value.

Benefits

Like every financial concept have their own benefits and limitations, so does this concept. Let us try to understand the benefits first.

  1. Limited Risks: This option is the fact that the risks in this option are limited to the extent the premium is paid towards the put option.
  2. Unlimited Profits: This is the fact that investors can earn unlimited profits using this option with defined risks.
  3. Leverage – Just as is the case with other option strategies, in this case too the investor gets the opportunity to control a larger position in the asset by giving a small amount upfront. Due to this opportunity, the investor is able to amplify the potential return when the asset price drops.
  4. Flexibility – The process offers flexibility to the investor to manage the downside risk. They can choose the strike price and the expiration dates as per their market expectations so that th strategy is designed to meet their expectations.

Drawbacks

The drawbacks of the concept are as given below:

  • No protection against rise in price– 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.
  • Limited time – The option has an expiration date within which if the price does not fall, then the option expires. The investor will lose the right to sell the option at the strike price.
  • Time decay – They are subject to time decay in the sense that if the price fall does not take place within the time limit, which is the expiration date, then the option contract loses its value. So it is necessary that the price decline happens quickly.

Long Put Vs Short Put

In this section we will try to understand the basic differences between the two types of option trading methods mentioned above.

Frequently Asked Questions ( FAQs)

How does a long put differ from a short put?

In a long put, an investor buys a put option, expecting the underlying asset’s price to decline. On the other hand, a short put involves selling a set option and obligates the seller to buy the underlying asset at the strike price if assigned. Long puts are used to profit from price declines, while short puts generate income but come with the potential obligation to buy the asset.

What factors should I consider when selecting a long-put strategy?

When selecting a long put strategy, consider the underlying asset’s volatility, the time to expiration, and your risk tolerance. Higher volatility and a longer time to end may increase the cost of the put option but provide more time for the underlying asset’s price to move in the desired direction.

Can a long put strategy result in a loss?

Yes, a long put strategy can result in a loss if the underlying asset’s price remains above the strike price or if the price decline is not significant enough to overcome the premium paid for the put option. The maximum loss is limited to the premium paid, but it’s important to carefully assess the risk-reward profile before entering the trade.

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