What it means
A put option gains value as the price of the underlying asset falls below the strike price. The person who buys it is "long" the put, and the person who sells it (writes it) is "short".
Because the buyer has a right and not an obligation, the most the buyer can ever lose is the premium paid. There are two main reasons to hold one.
A speculator who expects a share price to fall can use a long put to profit with limited capital and a capped loss. An owner of shares can buy a protective put, which works like an insurance policy because it sets a floor under the value of the holding.
The premium depends on the strike price, the time left to expiry, how volatile the market expects the asset to be, and interest rates. A put that is struck close to today's price costs more than one far below it, and a longer expiry costs more than a shorter one.
Time decay works against the buyer, because the option loses value each day if the price does not move. Each standard equity option contract usually covers 100 shares, so a quoted premium of $2.00 means a cost of $200 per contract.
The put can be sold before expiry for whatever it is then worth, which is how most traders close out positions rather than waiting to exercise. The main nuance is that the price must fall far enough, and soon enough, to cover the premium.
A share that drops only slightly, or that falls after the option has expired, can leave the buyer with a total loss of the premium.
In practice
Real-world examples.
Example
A portfolio manager holds 10,000 shares of a retailer ahead of an uncertain earnings report. She buys 100 put contracts as protection, accepting a known cost of a few thousand dollars in return for a guaranteed floor on the value of the position.
Example
An analyst at a hedge fund believes a software company is overvalued. Rather than short the shares and face unlimited loss, he buys puts so that the worst case is the $1,500 premium.
Example
A family business that holds a block of listed shares as part of its retirement fund buys puts to cover the period before a planned sale of the shares, locking in a minimum selling price.
Formula
Calculation
Break-even price at expiry = Strike price - Premium paid per share
Maximum loss = Premium paid per share x Shares covered
Maximum profit = (Strike price - Premium paid per share) x Shares covered, reached if the price falls to zero
Suppose an investor buys one put contract on a share trading at $52, with a strike of $50, a premium of $2.00 and 100 shares per contract.
Cost = $2.00 x 100 = $200, which is also the maximum loss.
Break-even = $50 - $2.00 = $48 per share.
If the share is at $40 at expiry, the put is worth $50 - $40 = $10 per share, or $1,000. Profit = $1,000 - $200 = $800.
If the share is at $55 at expiry, the put expires worthless and the loss is the full $200.Case study
Seen in the real world.
Northgate Logistics is an illustrative, fictional freight company whose owner held $600,000 of shares in a single listed supplier. A major contract renewal was due in three months, and she was worried the share price could fall sharply if it failed.
She bought protective long puts struck 10% below the market price for a total premium of $18,000. When the contract was lost and the shares fell 35%, the puts rose in value and offset most of the decline below the strike, limiting her total loss to roughly the 10% gap plus the premium.
In a fictional follow-up scenario the contract was renewed and the puts expired worthless, costing her the $18,000. She treated that as the price of insurance, which is exactly how a long put is supposed to be viewed.
Watch out
Common mistakes.
- Believing a long put has unlimited loss, when the buyer can never lose more than the premium paid.
- Forgetting the premium when working out break-even, and so overestimating the profit.
- Holding the put until expiry out of habit, when time decay may have eroded much of the remaining value that could have been sold earlier.
Questions
People also ask.
Is a long put the same as shorting a stock?
No. Shorting involves borrowing shares and has unlimited potential loss, whereas a long put has a capped loss and a different cost structure.
Do I have to exercise the put to make money?
No. Most traders sell the option back into the market before expiry, which captures its remaining value without handling any shares.
When does a long put lose money?
It loses when the underlying price stays above the break-even level at expiry, or when time passes and volatility falls without the price moving enough.
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