Do you know what a long put is in options trading? Long puts are the same as buying a put option, but with a different name. You go long or purchase a put when you believe the stock price is decreasing. One options contract is the equivalent of 100 shares of the stock. Puts are typically found on the right side of an options chain.
What Is a Long Put Option Contract?
In other words, you buy a long put option when you believe the underlying security price will go below the strike price before the expiration date. It’s one of the basic bearish strategies in that you think the price will decrease.
Advantages
- You make money when the price goes down
- Your downside risk is limited
- You can use them to hedge against investments moving in the wrong direction.
- Unlimited maximum profit
Disadvantages
- Potential to lose 100% of the premium paid
- An option will not trade 1 for 1 with the underlying security (delta needs to be accounted for)
- Your time is limited.
Put Buying vs. Short Selling
As a self-proclaimed lover of short selling, I got excited when I stumbled upon the notion of options trading and buying puts. The edge is in short selling, a bearish strategy that allows me to play with larger-cap stocks.
Long puts are similar to a short stock position in that your profits are limited. This is because the price of a stock cannot fall below $0 per share. So, in both scenarios, your profits increase in value the closer the stock price gets to $0.
With short selling, a trader sells a stock at a certain price and hopes it falls so they can buy it back at a lower price. The concept is the same for LP options; the trader hopes the underlying stock falls in price so the put option can be sold for a profit.
Selling or exercising your option will put you short in the underlying stock. This means you must buy the underlying stock to realize the profit from the trade.
What I Love About Puts
Brace your golf cart for this: what’s great about buying a put compared to short-selling a stock is that one does not have to borrow too short!
Hold on, it gets better! Your risk is capped at the premium you paid for the put option. In other words, you can’t lose more than that premium.
This is compared to the risk of losing all your capital when short-selling the underlying stocks outright. With a short stock position, your risk is unlimited since the stock price has no capped upside.
On the flip side, however, put options have a downside – they have a limited lifespan. The put option will expire worthless if the underlying stock price does not move below the strike price before the option expiration date. And you will lose the amount paid for the option.
Calculating Profit on a Long Put Option
We’re all about managing risk. I recently read in a book that the average new trader will blow up their account within 90 days.
And you want to know why? They don’t manage risk. What’s great about options is that risk management is built in. Sort of.
You still risk losing the premium paid for the option, but not the entire cost of buying the security outright.
No matter what, the risk of an LP strategy is limited to the price paid for the put, no matter how high the stock price is trading when the expiration date rolls around.
When purchasing a long put option, the maximum Profit is limited only to the put’s strike price minus the price paid for the option.
Here’s the formula for calculating Profit:
- Maximum Profit = Unlimited
- Profit Achieved When Price of Underlying = 0
- Profit = Strike Price of LP – Premium Paid
Calculating Loss on a Long Put Option
The formula for calculating maximum Loss on a long put option:
- Max Loss = Premium Paid + Commissions Paid
- Max Loss Occurs When Price of Underlying >= Strike Price of Long Put
Enter the fancy term of breakeven point(s). This is the point when you start making money from your put option. Enter the heel-clicking emoji. It can be calculated using the following formula.
- Breakeven Point = Strike Price of Long Put – Premium Paid
Here’s an example to help you understand the concept. Suppose the stock of TEE company is trading at $40. A put option contract with a strike price of $40, expiring in a month, is priced at $2.
You believe TEE stock will fall sharply in the coming weeks, so you paid $200 to purchase a single $40 TEE put option covering 100 shares.
TEE stock prices crash to $30 at the option expiration date.
With the underlying stock price now at $30, your put option will now be in the money with an intrinsic value of $1000, and you can sell it for that much. Since you had paid $200 to purchase the put option, your net profit for the entire trade is $800.
However, if you were wrong and the stock price had instead rallied to $50, your put option would expire worthless, and your total loss would be the $200 you paid to purchase the option.
Side note: I use a stock option for this example, but LPs can also use ETF options, index options, and futures options.
Using for Hedging
This may surprise you, but long put options can also hedge against long stock positions that move in the wrong direction—also known as a protective or a marriage put. They can protect you if your line drive decides to explore the trees.
If I confused you, hang tight; here’s an example of how you can use a put option to hedge your bets. Assume you bought 100 shares of Aramark (ARMK) at $25 per share. You invested in this stock for the long haul as you feel it will increase in value.
Unfortunately, you feel the stock price may fall over the next month due to increasing troubles with trade and tariffs. As a result, you purchase one put option (100 shares) with a strike price of $20 for $0.10 that expires in a month.
Put your hedge caps the loss to $500. Or 100 shares x ($25-$20) minus the premium ($10) paid for the put option.
To summarize, even if Aramark tanks to $0 in the next month, all you can lose is $510. This is because LPs cover all the losses below a stock price of $20.
Commissions
There are two things for certain in life: death and taxes. And you have to pay the tax, man. Similarly, with trading, you have to pay your broker.
For ease of understanding, I didn’t include the commissions you’ll need to pay. Typically, they vary from as low as $4 to as high as $20 per trade. However, it’s worth shopping around for active traders, as commissions can increase your profits.
It would be wise to look for a low-commission broker. Check out our extensive list of brokerages here.
Frequently Asked Questions
The investor believes that the security price will decrease with a long put. With a short put, the investor believes that the price of the stock will increase.
The risk of purchasing a long put is the investor losing the premium cost of the options contract plus commissions if the contract expires out of the money.
Investors make money by buying a long put when they believe the stock will decrease in price. If the underlying stock is trading at $50, they could purchase a contract with a strike price of $40.
