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.

Need Help Passing Your Series 4 Exam?

Selling Puts

Related Articles
  1. 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 ...
  2. 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.
  3. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  4. Trading

    Which Vertical Option Spread Should You Use?

    Knowing which option spread strategy to use in different market conditions can significantly improve your odds of success in options trading.
  5. Trading

    Option trading strategies: A guide for beginners

    Options offer alternative strategies for investors to profit from trading underlying securities. Learn about the four basic option strategies for beginners.
  6. Trading

    Manage Risk With Trailing Stops And Protective Put Options

    Using the right strategy can lower the risk of failure and protect your profits.
  7. Trading

    How to Sell Put Options to Benefit in Any Market

    Put selling can be a lucrative strategy as long as you're willing to own the underlying security.
  8. Managing Wealth

    Practical And Affordable Hedging Strategies

    Hedging offers a cost-effective way to transfer risk.
  9. Investing

    Prospering In The Next Bear Market: Here's How

    Prepare to survive, and even prosper, in the impending bear market, by considering and putting into action the following four strategies.
Frequently Asked Questions
  1. Do I have to complete all exams within a certain period of time to receive the CFA charter?

    According to the CFA Institute, a candidate can take as much time as necessary to complete all three levels of the CFA program.
  2. How Does Gross Margin and Net Margin Differ?

    Gross margin or gross profit margin and net profit margin are both profitability ratios used in determining the financial ...
  3. What is the difference between iShares, Vanguard ETFs and Spiders?

    iShares, Vanguard ETFs and SPDRs, or spiders, represent different exchange-traded fund families.
  4. How Does Gross Margin and Profit Margin Differ?

    Gross margin and profit margin are profitability ratios used in evaluating a company's financial health but have distinct ...
Trading Center