Anatomy of the Long Put

Posted on February 13th, by Mitchell Warren in Free Articles, Options Risk Management, Tutorials. Comments Off on Anatomy of the Long Put


Anatomy of the Long Put

When you are bearish on a stock or ETF, one way to express that view is by buying a put option. The long put is an aggressive, bearish options strategy, but is very easy to understand. By owning a put option you have the right, but not the obligation, to sell shares of that particular stock (or ETF) for the strike price of the option, in the future. Know that every put option controls 100 shares of the underlying.

Buying a put option gives you limited risk, (cost of the option), with limited reward (stocks can’t trade below $0.00).

Option expiration is the same for calls as it is for puts.  Monthly option contract’s last day of trading is on the third Friday of the month and expire on Saturday. Weekly option’s last day of trading is also on Friday, but they expire on the same day. Despite options have expiration dates, they can be bought and sold in the open market ahead of expiration.

Most long put trades are done as a hedge against the underlying equity. If you owned 1,000 shares of XYZ, you might buy 10 out-of-the-money (OTM) puts to protect against a drop in the stock. For example, say that XYZ was trading at $55 in December, and you purchased the Feb. $52.50 puts for $1.10 to hedge your stock. Even if the stock goes bankrupt in next few months, the most you can lose is $3.60 ($55-$52.50+$1.10=$3.60).

Example of a Long Put

Facebook (currently trading at $27.67)

Buy to open (FB Mar 16 ’13 $27 Put)

The (FB) Mar. $27 puts are currently trading for $0.74. So if you felt that shares of (FB) were about to sell off, one way to express that bearish view is by purchasing this put option. Instead of shorting 100 shares of the stock, tying up $2,767 in brokerage account, you can buy the put for $74 (one option controls 100 shares of stock), limiting your risk.

If Facebook shares fell to $25 by March expiration, your put option would be worth $2.00, resulting in a gain of 170%. However, if the stock is at $27 or above by Mar. expiration, the put option will expire worthless. Just like calls, puts can be sold before options expiration. So the stock moved sharply in one direction, you can close out the position during market hours (9:30 A.M.-4:00 P.M. EST).

One of the major difference between puts and calls is their delta. Calls have a positive delta, while puts have a negative delta. This means that puts have a negative correlation to the underlying, unlike calls. Using the Facebook example above, those puts have a delta of around -0.39. So for every $1.00 move in the stock, the put options will move $0.39 in the opposite direction. The delta of a put can range from -1.00 to 0.00.

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