Long Put

If you have a strong feeling that a stock will drop soon, you can short sell your stock. However, this is a risky strategy since you can suffer from unlimited loss if the price of the stock increases. As such, instead of short selling your stock, you can now use the long put. The long put gives you the right to sell your stock at a fixed price within a specified period of time.

For example, supposing ABC is trading at $32.14. Then there is the July 15 puts that are trading at $1.10. As such, for $110 you can now buy one July 15 put, since each option is for 100 shares. This gives you now the right to sell 100 shares at $30 per share. Supposing the stock remains or goes over the $30 before the expiration of the option, your maximum loss will be your investment or the cost of the option, which is $110. If the price of the stock drops to $22, then the put will be worth $8. Here your put is now $800. Your profit will be $690, which is equivalent to 627% profit gain on your investment. To have the same profit gain, the stock should increase to $1600 per share. Take a look at the following table:

Should the price of the stocks drop to $22:

 Start PriceEnd PriceProfit (L)% Gain (L)
Stock Price$31.80$22.00
Short 100 Shares$3,180.00$2,200.00$980.0030.8%
1 JUL 30 Put$110.00$800.00$690.00627%


Should the price of the rise to $42:

Start PriceEnd PriceProfit (L)% Gain (L)
Stock Price$31.80$42.00
Short 100 Shares$3,180.00$4200($1020)(32.1%)
1 JUN 30 Put$110.000($110.00)(100%)


Should you decide to sell your stock short at $30, then it suddenly surges to $40, you can then choose to buy the stock and therefore limit your loss. Here you will lose $100 (100 shares x $10). Supposing the stocks continue to rise, your loss would then be limited to the price of the puts, which is $110.

In order to profit from the trade, you have to be right about the price of the stock and when the price will occur. If the stock fails to reach the price and at the right time, the option will expire without value. What you have to remember is that a stockbroker is not much concerned with the timeframe because they can hold onto the stocks for years. Options however expire after the specified period, mostly in months. LEAPS or long term options expire in two or three years.


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