An investor who purchases a put believes that the underlying stock price will fall and that they will be able to profit from a decline in the stock price by purchasing puts. An investor who purchases a put can control the underlying stock and profit from its price decline while limiting their loss to the amount of the premium paid for the puts. Buying puts allows the investor to maximize their leverage while limiting their losses and may realize a more significant percentage return based on their investment when compared to the return that could be realized from shorting stock. When looking to establish a position the buyer must determine:

  • Their Maximum Gain
  • Their Maximum Loss
  • Their Breakeven

Maximum Gain Long Puts

An investor who has purchased a put believes that the stock price will fall. There is, however, a limit to how far a stock price may decline. A stock price may never fall below zero. As a result, the investor who believes that the stock price will fall has a limited maximum gain. To determine the maximum gain for the buyer of a put, use the following formula:

Maximum Gain = Strike Price – Premium

Maximum Loss Long Puts

Whenever an investor is long or owns a stock, their maximum loss is always limited to the amount they invested. When an investor purchases a put option, the amount they pay for the option or their premium is always going to be their maximum loss.

Determining The Breakeven for Long Puts

Whenever an investor has purchased a put, they believe that the stock price will decline. In order for the investor to breakeven on the transaction, the stock price must fall by enough to offset the amount of the premium paid for the option. At expiration the investor will breakeven at the following point:

Breakeven = Strike Price – Premium

Example:

An investor has established the following option position:

Long 1 XYZ May 30 put at 4

The Investor’s maximum gain, Maximum loss, and breakeven will be: Maximum Gain: $26 or $2,600 for the whole position (Strike price – Premium)

Maximum Loss $400 (The amount of the premium paid)

Breakeven = $26 = 30-4 (Strike price - premium)

If at expiration XYZ is at exactly $26 per share and the investor sells or exercises their option, they will breakeven excluding transactions costs.

Series 4 Exam Training - Securities Institute



Selling Puts

Related Articles
  1. Personal Finance

    Tips For Series 7 Options Questions

    We'll show you how to ace the largest and most difficult section of this exam.
  2. Trading

    Profiting From Stock Declines: Bear Put Spread Vs. Long Put

    If you're bearish, you should compare the risk/reward characteristics of these two strategies.
  3. Trading

    Bear Put Spreads: A Roaring Alternative To Short Selling

    This strategy allows you to stop chasing losses when you're feeling bearish.
  4. Trading

    Solving Mixed Options Problems On The Series 7

    Learn to ace the questions that involve both options contracts and stock positions.
  5. Financial Advisor

    How To Answer Option Questions On The Series 7 Exam

    Learn how to answer option questions on the Series 7 exam. Pass your Series 7 exam with the help of these tips.
  6. Trading

    How To Buy Options On the Dow Jones

    We show why buying options on the Dow Jones is a good alternative to trading the exchange-traded fund.
  7. Trading

    What Is A Bull Put Spread?

    Investopedia explains: A bull put spread is a variation of the popular put writing strategy, in which an options investor writes a put on a stock to collect premium income and perhaps buy the ...
  8. Trading

    Introduction To Put Writing

    Learn about a strategy that may be appropriate if you have a positive outlook on a stock.
  9. Trading

    Difference Between Short Selling And Put Options

    Short selling and put options are used to speculate on a potential decline in a security or index or hedge downside risk in a portfolio or stock.
  10. Investing

    Insure Your ETF Investments With Options

    Learn how to insure and hedge against unfavorable moves in ETF investments using options strategies, such as the protective put and the protective collar.
Trading Center