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domingo, 2 de noviembre de 2014

Strategies with options: Long Put, buying a Put option

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Buyers of a Put option seek to benefit from the price decreases of the underlying asset or protect long positions againts a possible drop in price. They have a bearish view of the market and expect that price volatility to increase.

The risk of this strategy is limited to the premium price paid by the trader at the beginning and profit potential is unlimited at maturity in a bear market.

The breakeven point in this trade, ie the point from which begins the potential for profit, is the strike price - the price of the premium. Furthermore, we note that its delta decreases to -1 as the underlying asset prices falls.

The more bearish the market expectations are, the Put option must be purchased in the deepest Out The Money possible position (premium and therefore costs are lower), ie the lowest strike price must be set for the buyer of the Put option.

The following example explains how the Put call strategy work:

Example of a Long Put

After an extensive analysis, an investor consider that the price of XYZ company stock can go down in the coming months. Currently, the price of XYZ stock is $40.Therefore, the investor buy a Put option on XYZ with a strike price of $40 and a premium of $2.00 USD/share. 

At maturity, the graph of profit / loss on the long Put is:

According to this chart, when the market price is lower than $35, the option produce earnings and the profit increase and is "unlimited" (until the underlying asset is zero) if the market price falls. At $35, the Put option is break even, while between $35 and $40 its loss will increase as the market price increase. Above $40, the investor loss is limited to the price paid for the premium, ie $2.00 USD/share.

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