Investing in a Market Downturn with the Bearish Long Put Option

What Is a Long Put Strategy?

A Long Put strategy is a fundamental strategy with a bearish market outlook, and it is precisely the opposite of the Long Call strategy. Using the Long put, you're attempting to profit from a drop in the underlying asset price. The risk is limited to the premium, but you enjoy limitless rewards.

The long put strategy is like to short selling a stock. Compared to short selling, this strategy has numerous advantages. This includes the absolute risk, the premium paid, and lower investment. The disadvantage of this strategy is that options have an expiry date, whereas you can hold stocks indefinitely.

Assume you are bearish on NIFTY and believe its price will fall. You can use a Long Put strategy by purchasing an At-the-money (ATM) PUT Option on NIFTY.

If the NIFTY share price falls, the put option will become in the money and have an intrinsic value. Profits could be unlimited as a result of this. If the NIFTY price rises, the put option will expire worthlessly, and the maximum loss will be the premium paid. This strategy has a low risk and a high reward.

How Does the Long Put Strategy Work?

The long put strategy for NIFTY, which is currently trading at 18000 (NIFTY Spot Price), looks like this:

Assume the NIFTY is trading at 18000. To implement this strategy, you will need to buy one NIFTY Put Option only if you expect the price of the NIFTY to fall short.

If the prediction comes true and NIFTY falls as predicted, the put option will be in the money, and you can profit from it. Such scenarios have the maximum potential for unlimited profits.

If the NIFTY rises, the put option will be worthless. You will lose only the initial premium amount you paid to enter this trade which is the maximum loss in this case.

When Is the Best Time to Long Put?

As a Long Put strategy implies a bearish outlook on a security's price movement, investors are more likely to plan and execute a Long Put strategy when they have a specific assumption or read about a security's expected decline.

Suppose you expect this drop to occur within a short period. However, the strategy allows for a broader range of expectations for a more extended fall period.

The impact of time decay is a notable feature at this point. The possibility of rust forming over the planned profits cannot be reduced for longer.

Investors frequently employ the Long Put strategy as a hedging tool.

As a result, if they already own security that may decrease in value in the future, integrating a Long Put strategy with it may prove financially viable.

Long Put the Hedging Option

Investors can also use a long put option to protect a long stock position from unfavourable price movements. A protective put, or a married put, is a hedging strategy.

Suppose the investor owns 100 shares of XYZ at a price of ₹25 per share. The investor is bullish on the stock long-term but fears that it will fall in the coming month. As a result, the investor pays ₹200(100×₹2) for one put option with a strike price of ₹20 that expires in one month (multiplied by 100 shares because each put option represents 100 shares).

The investor's hedge limits the loss to ₹500, or 100 shares x (₹25 - ₹20), less the premium paid for the put option (₹200 total). In other words, even if XYZ falls to zero over the next month, the trader's maximum loss is ₹700 because the long put option covers all losses in the stock below ₹20.

Is Long Put Strategy Worth the Effort

Compared to short selling, using the Long Put strategy will always be more beneficial to the investor. Because of the involvement of the maximizing attribute, there is a significant opportunity to generate high-quality returns. There is no upper limit to the downturn in security prices.

As a result, this strategy has the potential to generate an infinite profit. Furthermore, the profit is simple to calculate when the option's strike price differs from the amount of premium paid to obtain the options.

Because there is a cap on the maximum loss, the strategy's associated risk is also relatively low. An investor can most suffer a loss equal to the premium amount paid plus commissions.

As the market falls, the investor's profit will rise on the scale. However, the value of the options may deteriorate over time. As a result, the investor must make an informed decision regarding the strike prices.

For beginners, this directional strategy is simple to implement and comprehend. It is simple for an investor to take a position in this strategy and see it through to its expiration date.

Pros and Cons of Long Put Strategy

Like almost every other option strategy, the Long Put has benefits and drawbacks.

Advantages of the Long Put Strategy

• There is an unlimited profit potential with low risk.
• Shorting the stock requires less capital than outright shorting it.

Disadvantages of the Long Put strategy

• Time decay is the main drawback of the long put trading strategy.
• If the strike price, expiration dates, or underlying stock are not chosen correctly, the investor could lose the entire amount invested.

The Impact of the Long Put Strategy

You could have a maximum profit or a maximum loss by using the long put strategy as follows:

Maximum Profits With Long Put Strategy

The profit can be substantial when traders employ the long put strategy. If the stock falls to zero, you profit from the total strike price minus the cost of the put contract. Keep in mind, however, that stocks rarely fall to zero. So, be realistic, and don't expect to buy an Italian sports car after only one trade.

Maximum Loss with the Long Put Strategy

The risk is limited to the put premium paid.

Example

Let us suppose that the stock price of a security is ₹50. But you, the investor, expect a downfall within the next few days.

At the time of writing, at-the-money put options on the security are trading at ₹2 per option with a strike price of ₹50. As a result, you buy one contract with 100 options for ₹200.

To Sum Up

The Long Put strategy is a viable way to make desired profits when the underlying security's price falls. Numerous factors can cause the price of a security to decrease.

The strategy allows the investor to profit in various ways with a low-risk approach. This is why the strategy is a good investment. They can try to profit from market price movement.