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 (the put is in the money).
• If the stock’s market price rises above the strike price, the holder won’t exercise and will lose 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 holder the right to sell 100 shares of ABC at $75 per share. The premium is $6 per share, so the contract costs $600 total ($6 × 100). It expires on the third Friday in September.

The investor is expecting ABC’s market price to fall below $75 before expiration. If it doesn’t, the option will expire and the investor will have paid $600 for a contract they didn’t use.

Math-based options questions should be expected on the exam. They typically ask for 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 $0. 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:

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

With a strike price of $75 and a premium of $6, the maximum gain is $69 per share (or $6,900 total).

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 breakeven is $69 per share.

The investor can still have a loss if the stock 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. If the option expires worthless, the premium is lost. 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 paid in premium. If exercising would create a loss, the investor will not exercise.

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

Investors can also perform closing transactions to exit 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: