What Is A Long Put?
A long put option strategy is the purchase of a put option in the expectation of the underlying stock falling. It is delta negative and theta positive.
Introduction To The Long Put
Options are used by investors to take advantage of a wide range of projections on the state of the market.
Unlike stock investing, where only a rise makes money, options can profit from falls in the market, and a range of other market movements such as changes in a security’s volatility.
One such simple strategy used in the long put, detailed here.
Description of the Long Put Strategy
The strategy involves the purchase of a put option.
Puts give the buyer the right but not the obligation to sell the underlying security anytime* between now and the expiry date of the option.
* This is for ‘American’ style options – as compared to European options which can only be exercised on the expiry date, not before. Most options traded on the CBOE that we’ll cover are American options.
For example suppose a put option was purchased with a strike price of 140 and 3 months of time remaining until expiry. Anytime over the next 3 months we could exercise the option and sell stock for $140/share.
(If we didn’t own stock we could buy some immediately before exercising the option – brokers would just pay the difference to us).
When to put a Long Put on
A long put would be placed if we believed the underlying stock was to fall, and fall quite rapidly (as we will see the put loses time value).
Pros of Strategy
Long puts are a capital efficient position – only the cost of the option which is likely to be a fraction of the price of the stock is required.
They are also one of the few ways retail investors can profit from falls in stock prices. The alternatives such as shorting a stock are often unavailable or too capital intensive to non wholesale broker clients.
The position is also pretty simple compared to other strategies and options spreads we cover.
Cons of Strategy
Long puts are theta positive. Over time they lose value, all things being equal, and so any move down needs to be reasonably rapid to counteract this.
Care with the strategy needs to be taken if the stock has taken a large fall recently. Out of the money puts in particular are likely to be in demand, push up implied volatility and option price.
Should the stock rise back in value the puts will likely lose twofold: from the negative delta of the position and also the implied volatility falling back to normal levels. The put price is likely to collapse in this scenario.
Risk Management
As we’ve stated above, ensuring a long put position doesn’t have an elevated implied volatility on entry is the first risk management decision to make.
You should also consider reasonably long dated options – 30-90 days plus – to minimise the loss of time value. Theta on longer dated options is lower hence minimising the effect of time decay.
Another alternative is to sell an out of the money put to reduce the net cost of the strategy, and minimise time decay risk. This would turn the strategy into a bear put spread.
Conclusion
The Long Put strategy is great for being able to simply and easily profit on the fall of an underlying security.
However more sophisticated traders may be more attrated to more complex strateies such as the bear call spread to similarly profit, but as reduced cost and theta risk.
