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 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.
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For eg:
Source: Long Put (wallstreetmojo.com)
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.
Characteristics
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For eg:
Source: Long Put (wallstreetmojo.com)
- Decay Characteristics: As per this characteristic, the more time passes, the value of the position will decline when the same moves towards the expiration value.
- Loss Characteristics: This is an options trading strategyOptions Trading StrategyOptions Trading refers to a situation where the trader can purchase or sell a security at a particular rate within a specific period. Its strategies include Long Call Options, Short Call Options, Long Put Options, Short Put Options, Long Straddle Options, & Short Straddle Options etc. read more 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.
- 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 breakeven even 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 breakeven even point.
Long Put Trading Strategy
- When the investor expects the market to be in the bearishBearishBearish market refers to an opinion where the stock market is likely to go down or correct shortly. It is predicted in consideration of events that are happening or are bound to happen which would drag down the prices of the stocks in the market.read more 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 a 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-sellingShort-sellingShort Selling is a trading strategy designed to make quick gains by speculating on the falling prices of financial security. It is done by borrowing the security from a broker and selling it in the market and thereafter repurchasing the security once the prices have fallen.read more 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 prevail 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 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
- = $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 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.
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 a put option,” while in the case of a short put is “sell a put option.”
Benefits
- 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.
- 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 offer limited risks and unlimited profits to investors.
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