Long Put

A long put can be an ideal tool for an investor who wishes to participate profitably from a downward price move in the underlying stock. Before moving into more complex bearish strategies, an investor should thoroughly understand the fundamentals about buying and holding put options.

Market Outlook

Bearish sentiment among market participants.

When to Use

Purchasing puts without owning shares of the underlying stock is a purely directional strategy used for bearish speculation. The primary motivation of this investor is to realize financial reward from a decrease in price of the underlying security. This investor is generally more interested in the dollar amount of his initial investment and the leveraged financial reward that long puts can offer than in the number of contracts purchased.

Experience and precision are key in selecting the right option (expiration and/or strike price) for the most profitable result. In general, the more out-of-the-money the put purchased is the more bearish the strategy, as bigger decreases in the underlying stock price are required for the option to reach the break-even point.

Profit & Loss Chart

Benefit

A long put offers a leveraged alternative to a bearish, or “short sale” of the underlying stock, and offers less potential risk to the investor. As with a long call, an investor who purchased and is holding a long put has predetermined, limited financial risk versus the unlimited upside risk from a short stock sale. Purchasing a put generally requires lower up-front capital commitment than the margin required to establish a short stock position. Regardless of market conditions, a long put will never require a margin call. As the contract becomes more profitable, increasing leverage can result in large percentage profits.

Risk & Reward

Maximum Profit: Limited only by stock declining to zero.
Maximum Loss: Limited to premium paid.

Upside Profit at Expiration: Stock Price – Stock Price at Expiration - Premium Paid

The maximum profit amount can be limited by the stock’s potential decrease to no less than zero. At expiration an in-the-money put will generally be worth its intrinsic value. Though the potential loss is predetermined and limited in dollar amount, it can be as much as 100% of the premium initially paid for the put. Whatever your motivation for purchasing the put, weigh the potential reward against the potential loss of the entire premium paid.

Break Even Point

Strike Price – Premium Paid

Before expiration, however, if the contract’s market price has sufficient time value remaining, the break even point can occur at a higher stock price.

Volatility Changes

Increase In Volatility: Positive Effect
Decrease In Volatility: Negative Effect

Time Decay (Theta)

Negative Effect

The time value portion of an option’s premium, which the option holder has “purchased” when paying for the option, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration. A market observer will notice that time decay for puts occurs at a slightly slower rate than with calls.