Long Put

A long put is another simple option strategy, and involves buying (going long) a put option. Long puts are generally used by traders speculatively who believe that the underlying asset will decrease in value.

Many traders who buy puts and use this strategy, especially in registered accounts, will never exercise their rights to sell. Because you cannot short sell shares in a registered account, if you do not own the corresponding 100 shares per put contract, you cannot exercise your contract.

Most traders using long puts speculatively in registered accounts do not exercise their option, but rather sell the option contract back into the open market.

For example: If you own a put option with a strike price of $20 with a few days until expiration, and the stock is trading at $15, you could choose to sell the option back into the market for the intrinsic value of $5 (20-15) plus any minimal time value left.

Strategy benefits

• Speculate on price decreases in a registered account.
  • Registered accounts like TFSAs and RRSPs cannot short sell shares to speculate on price decreases. Buying a long put allows you to speculate on these decreases while following CRA rules for registered accounts.
• Speculate on price decreases with a lower cost basis than buying the underlying itself (in most cases).
  • For example: It is often cheaper to buy a put option than to maintain the margin to short sell 100 shares of the stock or ETF. If the price decreases significantly, the put option will generally increase more in value when compared to shorting the underlying itself.
  • This is due to the “built-in” leverage of option contracts since 1 contract represents 100 shares of the underlying.
• Take on less downside risk than shorting the underlying itself.
  • The maximum loss is always the entire premium you paid for the option, but this is often cheaper than shorting 100 shares of the underlying and having it rise significantly in value, causing you to cover at a loss.
  • When short selling stocks or ETFs, the theoretical maximum loss is unlimited since there’s no limit to how high a security’s price can rise. Buying a put option gives you a defined amount of risk since you can only lose the premium paid.
  • Put options with shorter times until expiration are cheaper since they have less time value, but are much riskier since the chances of expiring worthless are much higher. This is especially true for very “far” out of the money options.

Strategy downsides

• Your put option may expire worthless before your anticipated price decrease.
  • If you’re speculating by buying puts, and the stock price is higher than your strike price at expiration, the put will expire worthless.
  • Even if your strike price is higher than the price per share of the underlying, if you paid a significant premium for the put, your position may still not be profitable.
• Short-dated puts with less time until expiration will experience significant time-decay, and lose value every day as expiration approaches. Long-dated puts still experience time-decay, but at a less rapid rate.
• Puts where the underlying is experiencing high volatility (big swings in price) will be priced much higher than puts with an underlying experiencing low volatility (steady price, sometimes called trading “sideways”).
  • Buying (long) a put option when the underlying has high volatility comes with increased risk of losing some or all of your premium paid. If volatility on the underlying asset decreases from when you bought the option, you may realize a large loss in the value of the put.
  • For example: Your option has an implied volatility of 140% when purchased, but after a few days, has only 30% in implied volatility. Even if the underlying asset’s price has moved in your favour, the value of the option (your premium) may have decreased in value. 

Setting up the strategy

You buy a put option, this is often referred to as a Buy-to-Open or BTO order.

By buying the put option (or multiple contracts of the same put) you now have the right, but not the obligation, to sell 100 shares of the underlying stock or ETF at the strike price for every contract.

When choosing the strike price, consider the following:

• Strike prices that are In-the-money (ITM) or close to being ITM are more expensive since the odds of them being profitable at expiration are higher.
• Strike prices that are Out-of-the-money (OTM) are cheaper since the underlying would have to drop very sharply in value before expiration for the put to be profitable.

Long Put example

You think that stock XYZ will decrease in value over the next few weeks, and shares of XYZ are trading for $150 each. If you wanted to profit off the decrease in share price and shorted 100 shares, it would normally net you $15,000 in immediate cash proceeds. However, this would expose you to more risk than buying the put.

When you short sell, you are also responsible for paying the overnight borrow rate, and maintaining the appropriate margin requirements to short sell the security. If XYZ has a short MR of 50%, this is equal to $7,500.

Instead of shorting the shares, you instead buy a put option on XYZ with an expiration date 2 months away with a strike price of $140.

This put option costs $210 to purchase (premium of $2.10 x 1 put contract) and gives you the right to sell 100 shares of XYZ at $140 per share before the contract expires.

Possible results:

1. XYZ decreases in value to $120 in the next 4 weeks, and your put contract increases in value since it would now be profitable to exercise the contract. This price increase is at least equal to the intrinsic value. (Strike price of $140 - share price of $120 = $20 intrinsic value.)
   
   Rather than exercising the put (because you cannot short sell in a registered account, and don’t own the underlying shares), traders will choose to sell the put back into the market. The put itself will be worth at least the intrinsic value ($20 in this example) plus any time value left until expiration.     
   
   The total profit in this scenario is [$20 x 100 (representing one put contract)] - premium paid ($210) = $1,790. (Plus any time value left in the option since there’s still 4 weeks until expiry.) 
2. XYZ decreases in value to $139, however there’s only a week until your put expires. Since you paid a $2.10 premium per share, XYZ’s price would have to be lower than $137.90 for you to break-even. (Share price - premium paid)
   
   You can choose to sell the put back into the market at a loss, however the put will be worth only the intrinsic value of $1 (140-139), plus any very minimal time value since there’s only a week until expiration.
3. XYZ decreases in value, but only to $145 in the next 8 weeks. The put option you purchased expires worthless.
4. XYZ increases in value to $180 in the next 8 weeks. The put option you purchased expires worthless.
   • If you had shorted 100 shares of the underlying speculatively instead of buying the put option, you would currently be facing a $3,000 unrealized loss. ($15,000 net proceeds from entering initial short position - $18,000 outstanding value of shares short.)
   • With the put option, your total loss is only the premium paid ($210).

These scenarios highlight some of the potential outcomes from buying a Put option, including benefits, risks and a comparison to shorting the underlying investment itself.

Profit and loss explained

Maximum profit at expiration

Profit = [(Strike price - Share price of underlying) * 100 per contract] - Premium paid

Maximum profit = Strike price - Premium paid

Maximum loss

Total premium

Break-even at expiration

Break-even point = strike price of put - premium paid

Please note: You should consider the commissions paid as costs for these transactions in order to calculate your profit and losses.