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 put has intrinsic value and may be profitable to exercise (the put is in the money).
• If the stock’s market price rises above the strike price, exercising wouldn’t make sense, so the holder lets it expire and loses the premium paid (the put is out of the money).

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

Long 1 ABC Sep 75 put @ $6

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

The investor is betting 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 investor still has to earn back 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 is at $69 per share.

The investor can still have a loss if the market price doesn’t fall far enough below $75 to cover the premium. 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 result in 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: