An investor might use a long put option position when the share price or market is expected to decline.
A put option allows an investor to pay a fixed premium for the right, but not the obligation, to sell an asset at a predetermined price until expiration. The long put strategy might be useful for an investor who is bearish on either the market or the price of a specific stock. Investors going long puts may profit if the price of the underlying shares falls below the combined value of the strike price and the net cost of the option. The payoff from a long put position is substantial, increasing point for point with the stock’s decline if the price of the underlying shares moves lower. The loss potential is limited to the initial cost of the option. Investors face a maximum loss of the premium at any point at or above the strike price, below which point losses diminish. The value of a long put option is hurt by the passage of time and benefits from increases in volatility.
Long Put Example:
- Underlying XYZ stock price: $36.25
- Put strike price:35
- Put option premium:$2.00
- Days to expiration:90
- Breakeven: 35-$2.00=$33.00 (Strike price minus premium paid for put option)
- Profit potential: Limited, but substantial as the stock price falls. However, the profit potential is limited by the fact that the stock cannot trade below zero.
- Potential profit: @$30.00 – The put option is worth $3.00 to a buyer who paid $2.00, since profit = strike price minus underlying price at expiration less the premium paid, or $35.00 – 30.00 -$2.00 = $3.00.
- Maximum loss: Defined by the premium paid of $2.00. Occurs at the strike price and all points above.
Market Outlook – Bearish
Volatility View – Premium increases
Time Erosion – Premium decays
Dividends – Premium increases
Interest Rate – Premium decreases
Profit Potential – Limited
Loss Potential – Limited
Components – Buy put option
|Underlying Stock||$ 36.25||Underlying Stock||Profit & Loss|
|Long Call Strike||$ 35.00||$ 10||$ 2,300.00|
|Premium||$ 2.00||$ 20||$ 1,300.00|
|$ 25||$ 800.00|
|$ 30||$ 300.00|
|$ 35||$ (200.00)|
|$ 40||$ (200.00)|
|$ 45||$ (200.00)|
|$ 50||$ (200.00)|
|$ 55||$ (200.00)|
|$ 60||$ (200.00)|
|$ 70||$ (200.00)|
|$ 80||$ (200.00)|
Disclosure: Interactive Brokers
The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
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