Bear Market – Long Put

Study Notes:

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