Long puts

This chapter covers the fundamentals of long put options contracts. To get comfortable with the language used when discussing options, watch this video:

When an investor goes long a put, they’re bearish on the underlying security’s market price. Buying a put gives the holder the right to sell the stock at the strike price.

• If the stock’s market price falls below the put’s strike price, the holder can potentially profit. The put is in the money (think “put down”).
• If the market price rises above the strike price, the holder won’t exercise the option and will realize a loss equal to the premium paid. The put is out of the money.

Let’s work through a few examples to understand long puts:

Long 1 ABC Sep 75 put @ $6

This contract gives the right to sell ABC stock at $75 per share. The option costs $600 ($6 × 100 shares) and expires on the third Friday in September.

The investor is betting that ABC’s market price will fall below $75 before expiration. If it doesn’t, the option expires worthless, and the investor loses the $600 premium.

Math-based options questions should be expected on the exam. They typically ask about potential gains, losses, and breakeven values. Let’s go through each.

The maximum gain for a long put occurs if the stock’s market price falls to zero. Here’s what that looks like:

An investor goes long 1 ABC Sep 75 put @ $6. The market price falls to $0. What is the gain or loss?

Can you figure it out?

A long put’s maximum gain can be calculated with this formula:

$\text{Long put maximum gain}=\text{strike price}-\text{premium}$

The strike price of $75 minus the premium of $6 gives a maximum gain of $69 per share (or $6,900 overall).

Let’s look at an example that’s more likely to occur:

An investor goes long 1 ABC Sep 75 put @ $6. The market price falls to $60. What is the gain or loss?

Put holders don’t always make a profit. Even if ABC’s market price falls below $75, the holder must recover the premium to have an overall gain.

Let’s look at another example:

An investor goes long 1 ABC Sep 75 put @ $6. The market price falls to $69. What is the gain or loss?

When investing in puts, the breakeven can be found using this formula:

$\text{Long put breakeven}=\text{strike price}-\text{premium}$

With a strike price of $75 and a premium of $6, the investor breaks even when ABC stock is at $69 per share. At this market value, there is no profit or loss.

The investor can still have a loss if ABC’s market price doesn’t fall far enough below $75. For example:

An investor goes long 1 ABC Sep 75 put @ $6. The market price falls to $74. What is the gain or loss?

Expiration is the worst-case scenario for investors holding long options. In that case, the investor pays a premium for an option that is never used. The same applies to long put contracts.

An investor goes long 1 ABC Sep 75 put @ $6. The market price rises to $84. What is the gain or loss?

Long options can only lose the amount spent on the premium. If exercising would create a loss, the investor will let the option expire.

$\text{Long put maximum loss}=\text{premium}$

Investors can also perform closing transactions to close their options before expiration.

An investor goes long 1 ABC Sep 75 put @ $6. After ABC’s market price rises to $79, the premium falls to $2, and the investor performs a closing sale. What is the gain or loss?

Here’s a visual summarizing the important aspects of long puts: