Do you know what a long put is in options trading? Long puts are the same as buying a naked put option, just a different name. You go long or purchase a put when you believe that the price of the stock is going down. One options contract is the equivalent of 100 shares of the stock. Puts are typically found on the right side of an options chain.
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What Is a Long Put Option Contract?
Put simply, you buy a long put option when you believe the price of the underlying security 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 go down.
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 lost 100% of 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 must say when I stumbled upon the notion of options trading and buying puts, I got excited. Personally, I feel the edge is in short selling, a bearish strategy, and this is going to give me a chance to play with the 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 the price falls so they can buy it back at the lower price. The concept is the same for long put 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. Which means you will then need to actually 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, one does not actually have to borrow the stock to short!
Hold on, it gets better! Your risk is capped to the premium you paid for the put option. In other words, this means you can’t lose more than the premium you paid for the put option.
As compared to the risk of losing all your capital when short selling the underlying stocks outright. Because with a short stock position your risk is unlimited since the stock price has no capped upside.
On the flip side, however, put options do have a downside – they have a limited lifespan. If the underlying stock price does not move below the strike price before the option expiration date, the put option will expire worthlessly.
And, you will lose the amount paid for the option. In fact, we talk about long puts in our trade room.
How to Calculate Profit on a Long Put Option
- When purchasing a long put option, the maximum profit is only limited to the strike price of the put less 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 Long Put – Premium Paid
Limited Risk
We’re all about managing risk. Come to think of it, I recently read in a book 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 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 a long put strategy is limited to the price paid for the put option no matter how high the stock price is trading when the expiration date rolls around.
How to Calculate 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
When Do I Make Money With a Long Put Option?
Enter the fancy term of breakeven point(s). This is the point when you start making money from your put option. Enter 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 wrap your head around 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’s time is being priced at $2.
You believe that TEE stock will fall sharply in the coming weeks and so you paid $200 to purchase a single $40 TEE put option covering 100 shares.
Say your analysis was right; thanks to taking advantage of the Bullish Bears trading service. The price of TEE stock crashes to $30 at the option expiration date.
With 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, therefore, $800.
However, if you were wrong and the stock price had instead rallied to $50, your put option will expire worthless and your total loss will be the $200 that you paid to purchase the option.
Side note for this example, I use a stock option for this example but long puts are also applicable using ETF option, index options as well as options on futures.
Using a Long Put Option for Hedging
This may come as a surprise to you but long put options can also to used to hedge against long stock positions that move in the wrong direction. Also known as a protective put or a married put. They can protect you if your line drive decides to go 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 go up in value in the years to come.
Unfortunately, due to increasing troubles with trade and tariffs, you feel the stock price may fall over the next month. 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 simply, your hedge caps the loss to $500. Or 100 shares x ($25-$20), minus the premium ($10) paid for the put option.
To cut a long story short, even if Aramark tanks to $0 in the next month, all you can lose is $510. This is because all the losses below a stock price of $20 are covered by long puts.
Commissions
There are two things for certain in life, death and taxes. And you gotta pay the tax man. Similarly with trading, you gotta pay your broker.
For ease of understanding, I didn’t include the commissions you need to pay. Typically they vary from as low as $4 to as high as $20 per trade. However, for active traders, It’s worth shopping around as commissions can really eat up your profits.
It would be wise to look for a low commission broker. Check out our extensive list of brokerages here.
If you need more help, take our options trading course.
