Buying Puts (Long Puts)
Buying Puts (Long Puts)
If a call option gives the holder the right to purchase the underlying at a set price before the contract expires, a put option gives the holder the right to sell the underlying at a set price. This is a preferred strategy for traders who:
Are bearish on a particular stock, ETF, or index, but want to take on less risk than with a short-selling strategy
Want to utilize leverage to take advantage of falling prices
A put option works effectively in the exact opposite direction from the way a call option does, with the put option gaining value as the price of the underlying decreases. Though short-selling also allows a trader to profit from falling prices, the risk with a short position is unlimited because there is theoretically no limit to how high a price can rise. With a put option, if the underlying ends up higher than the option's strike price, the option will simply expire worthless.
Example
Say that you think the price of a stock is likely to decline from $60 to $50 or lower based on bad earnings, but you don't want to risk selling the stock short in case you are wrong. Instead, you can buy the $50 put for a premium of $2.00. If the stock does not fall below $50, or if indeed it rises, the most you will lose is the $2.00 premium.
However, if you are right and the stock drops all the way to $45, you would make $3 ($50 minus $45. less the $2 premium).
Risk/Reward
The potential loss on a long put is limited to the premium paid for the options. The maximum profit from the position is capped because the underlying price cannot drop below zero, but as with a long call option, the put option leverages the trader's return.
Buying Puts
