Long Put Strategy

 

“The Long Put is a limited risk/unlimited to $0 reward play”

 

Overview/General Remarks

Much like the long call the long put is similarly enticing. It leads the new trader to believe they’ve found a way to profit from a decline in price without being short any shares. Don’t be fooled!

Price doesn’t usually move very far in one direction or another without a catalyst.

As mentioned on the long call page here, many catalysts can occur they just don’t happen often enough to play the guessing game at when they might.

 

Expectations

Employ this strategy with the expectation that price will decline immediately.

Setup/Construction

Buy a put option at any desired strike. Most people believe ITM long options are the best way to play it but I’m not so sure. They’re expensive and if price moves sideways or rise you’ll be looking at even greater losses.

OTM long options are generally viewed as “lottery plays”. They fail often but when they succeed it’s usually a big bang for only a few bucks.

 

Example Long Put

 

The horizontal section of the blue line represents the max loss or the debit paid. Anything above the zero line sloping upward represents the profit potential for the long put. Looks incredible I know, but looks can be deceiving.

 

Example trade on SPY. Click to Enlarge.

 

Max Reward/Loss

Max reward = theoretically unlimited (remember price will need to move fast)
Max loss = limited to the debit paid to enter.

 

Price Assumptions

Price will need to decline substantially in a short period of time.

 

Leverage

Leverage for put options works exactly the same as for call options only from a drop in price. Assuming a well capitalized trading account it would be possible to short 100 shares.

If share price fell $1 to $217.54. You would realize a $100 gain or less than .5% from a 100 share short position.

A $1 fall in price for the put option shown above would yield, all things constant, ~$48 gain or ~12%.

The long put minimizes total capital at risk and offers much higher percentage gains.

 

Pros/Cons of the Long Put

Pros

– Limited risk

– Unlimited reward

– Easy to trade

– Volatility increase and price decline.

 

Cons

– Low rate of success

– Time decay

– Wild P/L from day to day

 

“The Greeks”

The greeks for the long put work much like the long call with only one difference. Delta has a negative sign attachment. This signals nothing more than what we already know, we need a move down in price. For a review of the greeks as they relate to long options click here.

 

Volatility

The effect volatility has on long options cannot be overstated. A sharp volatility decline will crush a long put or call. However a sharp increase will benefit the position greatly.

For this example;
IV = 13.63%
IV rank = less than 1%

 

Liquidity

Just be sure to check open interest, volume, and bid/ask spread.

 

Probability ITM/OTM

We want long options to move into the money. The probability of ITM for this long put is 50%.

 

Final Thoughts

I’ll avoid any lengthy discussion about compiling the information you’ve already learned from the long call page.

Given other good criteria I would generally like this trade at this time. Volatility is low and a decline in price would benefit our long put from the decline in price itself as well as the volatility increase.

Have questions. Ask me below.

 

Disclaimer

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