Options in the stock market give you, well… options! Puts are one of the many ~options~ to choose from. Long puts allow you to capture profit if the underlying price is falling, and with short puts you actually capture profit if the underlying price stays the same.
Wait, what? Profiting if the price doesn’t move?
If that seems confusing, you’re not alone. Worry not, though, we’ll give you an in-depth guide of puts here so that you know them well enough to incorporate into your investment moves.
Let’s jump in.
The Definition of Long Put and Short Put
“Puts” are a type of options contract that gives you the right to sell a stock at a set price, known as the strike price, over a set period of time. There are two main types of put options: long puts and short puts.
A long put is when you buy a put option, which means you pay a premium (the price of an option contract) for the right to sell a stock at the strike price. This can be a good strategy if you think the price of the stock is going to go down in the future, because you can sell the stock at the higher strike price and make a profit. However, if the stock price goes up instead, you may lose money on the premium you paid for the option.
On the other hand, a short put is when you sell a put option, which means you receive a premium for giving someone else the right to sell a stock at the strike price. This can be a good strategy if you think the price of the stock is going to go up or stay the same, because you get to keep the premium as profit. However, if the stock price goes down below the strike price, you may be assigned the contract – meaning you’d end up having to buy the stock at the higher price and take a loss.
Understanding How Long Put Works
A long put strategy is the opposite of a short put strategy, and is typically used when an investor is bearish on the stock, meaning they believe the stock will decrease in price. With a long put strategy, an investor buys a put option at a specific strike price, giving them the right to sell the stock at that price. If the stock price does decrease, the investor can exercise the option and sell the stock at the higher strike price, thus making a profit.
Basics of How Short Put Works
Basically, with a short put strategy, an investor sells a put option at a specific strike price, meaning they are obligated to buy the stock at that price if the buyer of the option decides to exercise it. This strategy is typically used when an investor is bullish on the stock, meaning they believe the stock will increase in price. By selling the put option, the investor collects a premium upfront, which can help to offset any losses if the stock does not increase in price.
Comparing the Differences: Long Put vs. Short Put
The main difference between a long put and a short put is the direction in which the investor thinks the stock price will move. A long put is a bearish strategy, while a short put is a bullish strategy. With a long put, the investor buys a put option, giving them the right to sell the stock at a specific price. With a short put, the investor sells a put option, giving them the obligation to buy the stock at a specific price.
Risk and Reward
Both long put and short put strategies come with risks and rewards. With a short put, the investor is obligated to buy the stock at the strike price if the buyer of the option decides to exercise it, which can lead to significant losses if the stock price drops. With a long put, the risk is limited to the premium paid for the option, but the potential reward is unlimited if the stock price drops significantly.
Both long put and short put options are affected by volatility, as higher volatility increases the value of the options. However, long put options benefit from higher volatility, while short put options are negatively impacted by it.
The price of a put option is affected by several factors, including the price of the underlying stock, the strike price, the time until expiration, and volatility. As a result, the price of a put option can fluctuate significantly over time. Due to the risk involved, one way to bolster a trading strategy is to subscribe to stock alerts from experienced traders – and receive notifications of potential setups to look into.
When and How do Investors Use Long Put and Short Put
Investors can use long put options to protect against a decline in the stock market or to speculate on a drop in the value of a specific stock. Short put options can be used to generate income in a stable or rising market, or to acquire a stock at a lower price.
Puts will earn an investor profit when the security they’re associated with declines in price, therefore they should be used when an investor feels bearish. Here’s an example: say you think Netflix’s price is going to fall because you read in the news that they might increase their monthly subscription fee.
Let’s imagine the current market price for Netflix stock (NASDAQ:NFLX) is $185, so you decide to purchase a put option at a $190 strike price. If the price falls, the value of the put will increase, and you can sell the contract to close the position and profit from the difference in premium.
Another great situation to use put options is when you want to hedge a long position you have taken. For example, if you long 100 shares of Tesla (TSLA) and you want to protect that investment in case TSLA’s price falls, you can purchase a put option along with the 100 shares you long.
In this way, you are protected if the price goes down because you lock in a price to sell the 100 shares, as opposed to being forced to sell at the current market price. Here, put options can be used as a means of hedging or risk management.
Short puts are a little less straightforward than long puts. You’d typically want to short a put (or a call) when you feel that the underlying price is going to remain relatively stable.
Advantages and Disadvantages of Using Long Put and Short Put
The advantages of using long put options include the potential for unlimited profit and limited loss, while the disadvantages include the cost of the premium and the potential for the option to expire without being exercised.
The advantages of using short put options include the ability to generate income and the potential to acquire a stock at a lower price, while the disadvantages include the obligation to purchase the stock at the strike price and the potential for unlimited losses if the stock price falls below the strike price.
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In the world of options trading, puts and shorts can be used to achieve a variety of different trading goals. They’re generally associated with bearish strategies, especially long puts, but can also be used as insurance for bullish plays. And short puts profit if the underlying price has little movement.
It’s clear that puts are a versatile investment – you can use them in a myriad of strategies. Keep a trading journal handy record when you use them, how you use them, and what worked for you and what didn’t. Over time you’ll build a nice picture of the market and feel like your finger is on its pulse.
Whether you take the long way or the short way, we wish you well in your investing quest.
Long Put vs. Short Put: FAQs
What Does a “Long Put” Mean?
Long and put are common words we use, and the vast majority of the time we don’t use them to refer to investments, but in the case of options, a long put translates to “buying a bearish investment”. Long meaning to own, purchase, buy. Put being the name that represents a bearish type of option contract.
What is a Short Put?
A short option is essentially the same as a long put, only it works in reverse. Instead of buying a put you sell a put. And instead of being a bearish play it is more neutral, to slightly bullish.
Is it Better to Short Puts or Buy Them?
This really just depends on your specific situation. Options are a set of tools. Say you’re building a house, at one point you need to drive nails into wood, and at another point you need to cut a piece of wood in half. You use two different tools for two different tasks, and this works the exact same way with options. A short put can be better than a long put, and visa versa, it’s up to you to use them effectively.
Is a Long Put Bullish?
No. A long put is a bearish strategy, as the value of a long put increases as the underlying price decreases in value.
Should I Buy In the Money (ITM) or Out of the Money (OTM) Puts?
ITM puts are going to cost more than OTM puts, same as calls. ITM calls are less risky, and will therefore be more expensive. And risk equals reward (and loss). So the more risk you’re willing to take on, the more you have potentially profit. But if your OTM put expires and it’s still OTM, you’ll lose what you initially spent to get it.
How Can I Decide Which Strategy is Right for me?
Figuring out what works and what doesn’t is a personal journey that involves experimentation. Everyone is different, so you need to find what resonates with you. We feel that the best way to do this is by trying things out. This might sound daunting because real money is involved, but worry not!
Paper trading allows you to trade risk free. So try paper trading, experiment, write down your successes and failures, meditate on those, implement your findings from that, and then keep adding and chipping away! Be patient with yourself, figuring out an investment strategy that’s right for you takes time, but is very worth it.