UK Accounting Glossary
A long put is a relatively straightforward options strategy. In a long put, a bearish investor buys a put option, waits for the value of the underlying security to fall below the strike price less the premium, and profits upon exercising the option. If the underlying security fails to fall below the strike price, the entire investment (i.e. the premium paid to purchase the put option plus commission) made by the long put trader will be lost.
For example, an investor who wants to make a long put trade on XYZ, Inc. when its stock is trading at $42 in August might buy a September 40 put option for 100 shares. Assume it costs the trader $2 purchases the put option — $200 premium ($2 X 100 shares). If XYZ’s stock price falls to $35, the put option would be in-the-money for $5 ($40 minus $35) and the purchaser of the long put could sell the 100 shares of XYZ for $40, netting $500 from this long put strategy. However, the overall profit from this long put trade would be $300 ($500 minus the $200 premium). On the downside, XYZ would need to drop to at least $38 for the long put strategy to break even. The above example does not take into account the commissions required to implement the long put strategy.
A long put is sometimes preferred to selling short. In a short sale, the investor borrows a security, sells it on the open market, buys it back when its value drops and returns the security to the broker for a net profit. Whereas in a long put, the investor only pays the premium for the right to sell the security. If the long put is successful, the investor can buy the security at the market price and immediately sell it at the higher strike price. Furthermore, a long put can carry less risk than a short sale. In a long put, the maximum loss is the premium of the put. In a short sale, potential losses are unlimited because stock prices can theoretically climb to infinity.
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This glossary post was last updated: 10th February 2020.