Buy put (Long put)

Buying a put gives the holder the right to sell the underlying asset  at the strike price.

Holding a put is most commonly used in two ways, as a protective put, or a long put.

A long put is a way to profit from a bearish movement, as the stock drops below strike price, the difference is a profit to the holder.

The protective put is effectively an insurance policy for a long position on the stock, as the stock’s value drops below the strike, the put’s value will rise.

Consider this example of a long put:

Buy 1 HSOL 45 days $4 at $0.10

Our trader Helena is looking for a correction in the HSOL prices within the next month and a half. This position gives her the right to sell 100 shares of HSOL at $4 a piece until expiration.

If the stock is less than $4 at expiration, she will have profited from the difference in price, minus the premium, if it is above $4 she will have lost the premium completely.

The trade off with having a short position in the stock itself is that the maximum loss, when buying a put, is the premium, often times a fraction of the cost of the 100 shares it represents. There is also a margin requirement associated with shorting, that may not be available to all traders, most brokers will allow buying puts as long as the cash is available in the account.

So when you short a stock the risk is unlimited, with a put your risk is limited to the premium paid.

Figure 1 is the at expiration diagram of Helena’s position.

Figure 1 the long put position, is profitable in a bearish market

Figure 1

Volatility here raises the premium, which may be interesting for traders who might not want to hold the put until expiration, and profit from the contract’s price fluctuations. However, the time until expiration also affects the price, the more time, the more expansive the contract.

Buying a put can be combined with a long position on an asset to offset the losses. This is effectively an insurance contract on the position.

This common strategy is called the protective put, let’s look at an example protective put our trader Ana takes on HSOL:

Owns 100 HSOL at $5.50

Buy 1 HSOL 20 days Put 5 at 0.1

If the stock is currently trading at $5.40 and Ana forecasts a dip in stock price within the next 20 days, she can cover her potential losses with this protective put position, as the price drops. Note that a protective put can also be bought at the same time as the long stock position, and in that case it will be considered a “married put”.

Figure 2 illustrates Ana’s position.

Protective puts can be a profitable way to insure losses on a bearish market, while still raking the benefits of owning the stock, such as dividend yield.

Overall, long puts are a safer way to profit from a bearish market, then taking short positions with margin requirements.

Share

Market and trading news