A long put refers to buying a put option, which is typically done in anticipation of a decline in the underlying asset. Despite the term “long,” there’s no inherent relation to time but rather describes the action of purchasing the option with the hope of selling it at a higher price later.
A trader may buy a put option for speculative reasons, betting that the underlying asset will fall and increase the value of the long put option. Alternatively, a long put can be used to hedge a long position in the underlying asset. If the underlying asset drops, the put option increases in value, helping to offset losses in the underlying.
Key Takeaways
- A long put signifies buying a put option and is inherently bearish.
- The strategy is adopted by investors expecting a security’s price to drop.
- Long puts can be used for both speculation on price declines and hedging against downside losses.
- Using a long put options strategy limits downside risk effectively.
Understanding a Long Put
A long put has a strike price, representing the price at which the purchaser of the put option has the right to sell the underlying asset. Assume the underlying asset is a stock with a $50 strike price. This means the put option allows the trader to sell the stock at $50, regardless of whether the stock price drops to $20. Conversely, if the stock price rises above $50, the option becomes worthless.
If the trader decides to activate their right to sell the underlying asset at the strike price, they will exercise the option. Exercising is not mandatory, and instead, the trader can exit the option any time before expiration by selling it.
A long put option may be exercised before expiration if it is an American option, whereas European options can only be exercised at expiration. Early exercise or expiration in the money makes the option holder short in the underlying asset.
Long Put Strategy vs. Shorting Stock
A long put can be a preferred strategy for bearish investors compared to shorting stock. A short stock position carries theoretically unlimited risk if the stock price rises significantly, while its profit potential is capped since a stock price can only drop to zero. Long put options offer similar profit potentials but with limited risk, constrained to the premium paid for the option.
The major drawback is the need for the underlying price to fall before the expiration date, or else the option payment is lost. To profit from a short stock position, a trader sells a stock hoping to buy it back at a lower price later. In similar fashion, a put option’s value increases as the underlying stock falls, and the option can then be sold for a profit. If exercised, the trade results in the trader going short in the underlying stock, requiring subsequent repurchase to realize the profit.
Long Put Options to Hedge
A long put option can also be used to protect an unfavorable move in a long stock position, known as a protective put or married put.
For example, an investor holding 100 shares of Bank of America Corporation at $25 each might be long-term bullish but cautious of a short-term decline. The investor buys a put option with a $20 strike price at a cost of $0.10 (or $10 total for 100 shares), expiring in one month.
This hedge limits the potential loss to $510, consisting of $500 (100 shares x ($25 - $20)) plus the $10 option cost. Even if the stock price drops to zero, the investor’s maximum loss remains capped at $510 due to coverage below $20 provided by the long put option.
Example of Using a Long Put
Imagine Apple’s shares are trading at $170 each and you anticipate a 10% decline before a new product release. You decide to buy 10 put options with a $155 strike price, paying $0.45 per option. The total cost for this position is $450 plus fees and commissions (1,000 shares x $0.45 = $450).
If Apple’s shares fall to $154 before expiry, your put options are worth $1.00 each, since you can go short at $155 and immediately cover at $154.
This makes your options worth $1,000 (1,000 shares x $1.00 = $1,000), resulting in a 122% profit (($1,000 - $450) / $450). Thus, a long put option allows for a much greater gain than the 9.4% drop in the stock’s price.
Conversely, if Apple’s shares rise to $200, the option contracts expire worthless, leading to a loss of the initial $450 position cost.
Related Terms: put option, strike price, exercise, expiration, premium
