Long Put Option Strategy – Buying Put Options
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Long Put Option Strategy – Buying Put Options


Hey everyone. This is Kirk, here again at
optionalpha.com. And in this video, we’re going to be talking about one of the simpler
strategies, and some of the basic building blocks of options, and that is the long single
put option. So as always, we’ll start here with the market
outlook for just a single put option. A long put is basically an expectation that the price
of a stock is going to drop. I mean, that’s really the essence of what you want to do.
This is different than if you short a stock. If you short a stock, you expect the market
to drop. But you also have that risk when shorting stocks that the market could rise
and rise significantly against your position. With a long put, you have limited loss, so
your losses are capped at the price of the option in which you buy. So, you can’t lose
any more money than what it cost you to get the contract. So, compared to shorting shares
outright, like I said, a put option gives the buyer the power of leverage. And since
one contract will control 100 shares of stock, so instead of shorting 100 shares of stock,
just simply buy one put option. Again, the whole idea here with a put option is that
you want to profit from a decline in the value or price of the underlying stock. Now, how to set it up? It’s very easy to set
up since it’s just a single leg order. You’re simply going to buy a put option with the
strike price and expiration period that you desire. So again, you can buy these front
month, you can buy these a couple of months out, and you can buy them at virtually any
strike price you want in and around the market price. The more bearish you are on the stock,
the further out of the money you’re going to be when you buy the option. So for example:
If the stock is trading at 50, (for example) we could buy this out of the money 40, and
we’d be really expecting the stock to be dropping more than $10 for us to make money. Again,
you can see how bearish we are. This option is going to be much cheaper. Now, let’s say
that we are moderately bearish. We could actually have a stock that’s trading at 40 and buying
at the money put. That’s going to cost us a little bit more money, but the stock doesn’t
have to drop as much from that point for us to start to make money. So again, the more
bearish you are, the further out of the money you can go. What’s the risk? Well, the maximum loss again,
like I said, is limited. It’s limited to just the amount of money that you paid for the
option. So, if the option does expire worthless, (in this case, if the stock stays flat or
rises during the expiration cycle) then you will lose money unless you close out the trade
early. But again, the most you can lose is just the premium that you paid for the option
to begin with. Now, the profit potential on all long options
is theoretically unlimited. For put options, it’s actually unlimited to zero because a
stock can’t drop below the price of zero. So, if the stock does drop to zero though,
then you make as much money as you can possibly make on this option. Now, that rarely happens,
unless the stock goes bankrupt or something like that. But you will have the chance to
make some significant gains if the stock does continue to fall. Volatility does play a really big impact on
long options, but it’s actually in your favor. All other things being equal – Increases in
implied volatility, such as general volatility in the marketplace, not necessarily in the
underlying stock, is going to boost the value of the option because there is a greater probability
that the stock is going to swing into that profit zone. So, volatility is going to be
good for your stock. Obviously for put options, volatility is even better since volatility
tends to correlate with falling stock prices. So as the stock falls, that’s great. Volatility
increases, that’s also great. So, these can be a real, real big money where if you do
catch a stock right at the beginning of a downtrend. Time decay for these are going to actually
hurt you since the passage of time decay is going to impact this strategy. We know that
options have a finite life. And therefore, it’s kind of “make it or break it” with all
long option contracts. So, the stock has to move quickly and it’s got to move before your
expiration period. It’s got to move into that profit zone before expiration. If it doesn’t,
then it’s going to start to decay in value because the time left to make money is running
out. So that value disappears, and then all that’s left is the intrinsic value. And if
the option is out of the money, then that becomes zero. Breakeven points again, are very easy to calculate
on these single leg options since it’s the building blocks of most strategies. All you’re
going to basically do for a long put option is take the long put strike (which in this
case, is going to be $40) and you’re going to subtract the premium that you paid because
you want to make back at least that premium. And that gives you our breakeven point. So
on this particular graph, we’d take 40 minus the 200, and that would give us our breakeven
point or the point in which it crosses this zero barrier. After that, then you’re going
to start making a net profit on the trade overall. Well, let’s look at an example real quick.
Let’s say the stock price is trading at $40, so right here where my cursor is. We’re going
to buy one 40 put for $200. That’s the cost of that option. So, that $200 is going to
be a debit on the trade. We’re going to outlay that money. We don’t get that money in. It’s
a cost of buying the option, so we give it to the market. And that also becomes our max
loss. We can’t lose any more than that $200. That’s the cost of the option. Now, the maximum
profit here is unlimited, right? It can go all the way to zero. Obviously, that’s rare
to happen, so don’t count on it. But theoretically, you could have unlimited profits to the downside. Some tips and tricks regarding long put options:
Puts are great for hedging and protecting stock positions. Like I said, what is really
good about puts is that they work well in down markets, and down markets usually have
volatility which also works well for put options. So, it’s kind of a double, or I guess, twice
as much protection as you would with anything else. You’re just shorting the stock generally.
So, I do like puts when used for hedging or protecting a stock position. You can use it
on a multitude of different strategies, but I really like out of the money puts for hedging. It’s important that you understand how a put
works independently of everything else, so that when you combine these with other options,
you have different option strategy payoffs. So as always, go back through this video if
you didn’t catch something or wanted to hear me say it again, or check out some of our
other videos to learn about different option strategies. But it’s important to understand
how these single leg options work independently of everything else, so that when they’re combined
with different strategies, you can overlap the features. Remember to focus on at the money or slightly
out of the money options put, not call, put options when buying for speculation, and deep
out of the money options for hedging purposes. Again, you don’t want to buy those deep out
of the money options even though they’re really cheap. Really cheap options don’t have a high
probability of making money. That’s why they’re cheap, because they’re not worth anything.
So, if you’re going to make a speculative move and you think that the stock is going
down, try to focus on some at the money or slightly out of the money options, and then
just get out of them quickly if they do create a profit. Get out of the trade and take your
profit as soon as you can see it. So as always, I hope you guys enjoyed this
video. And thanks for watching. Take just two seconds here if you like the video and
share it right below here on any of your favorite social networks with your friends, family,
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