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.

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.

• 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 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.

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 asset is higher than the strike price 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.

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 option.

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 strategy 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.

• When the investor expects the market to be in the bearish 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 benefit 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, which is also explained in the long put chart.
• This is similar to that of the short-selling 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 including 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.

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

• = $6 * 100
• The total price of the put options at the time of expiration = $600

• Profit = $600 -$300
• Profit = $300

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 hedging purposes if he or she is seeking to safeguard an underlying asset that is owned against a probable reduction in its value.

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.

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.

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

• 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.”

This has been a guide to what is a Long Put. We explain its differences with short put, with graph, strategies, example, trading strategy & when to use. You can learn more about from the following articles –

• Option Contract
• How to Trade Options?
• Stock Options
• Option Chain