Introduction

You believe that the stock you have been researching is going to decrease in price during a given time frame regardless of general market conditions. You are familiar with short stock positions but are wondering if there is a less risky way to express this investment idea through a trade.

Options, a type of derivatives contract, are one possible solution for efficiently gaining exposure to stock performance. They are classified as derivatives because the value of the options contract is “derived” or based on the price of something else (in this case, a stock). Remember that with all choices there are risks and benefits that we need to fully understand. This allows us to make informed decisions before using products to express investment opinions.

Put options give the holder the right, but not obligation, to sell a security (like a stock) at a predetermined price known as the strike price on a future date in time. Let’s explore this building block of financial choice in greater detail together.

Fun fact: Why is it called a “put”? Quite simply because the purchaser of a put option has the right to “put up for sale” the stock or underlying.

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What is a Long Put?

First, let’s learn options contract language to understand what we are buying when we purchase, or are “long,” a put option. Each standardized listed options contract has a minimum set of specifications that sets the terms of the agreement between the buyer and the seller:

• Quantity – The number of contracts you are purchasing
• Underlying – The security (stock, index, etc.) that the option’s value is derived from
• Expiration – The specific date and time an options contract expires
• Strike Price – The price at which an option can be exercised (or converted to the underlying)
• Type – Call or Put
• Price – The price that the option is bought (or sold) for
• Style – American (can exercise your right on or before expiration) or European (can only exercise your right on expiration)
• Settlement Style – Physical (the underlying security is delivered) or Cash
• Contract Multiplier – The number of underlying shares or units represented by one contract; for our examples we will assume a 100 multiplier, meaning each contract represents 100 shares or units of the underlying

With that in mind, we can now explore what it means to purchase a put or have a long put position. A long put is the right, but not the obligation, to sell stock at the strike price on a future date in time.

When you purchase long put contracts, it will cost you money to establish this position. Let’s refer to this initial cost as the premium paid. The net premium paid also includes the price of the option plus fees and commissions.

As a strategy, the long put is considered a “single-leg” strategy because it utilizes only one options contract. As we build on our understanding, we will explore two-leg and multi-leg strategies as well.

Put options, by design, are capital-efficient ways to express a bearish opinion on a stock or the market; we anticipate value decreasing and price declining. This is one benefit of long put options. The trade-off is that it costs money to purchase this access (right) to the significant, but limited, downside potential of the underlying. Another benefit of long put options is they limit your risk (or loss) exposure to a rise in the underlying price, should the value of the stock increase.

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Example

Buy 10 XYZ January 50 puts for $1.30

Assume the current XYZ stock price is $50

• Quantity – 10 contracts
• Underlying – XYZ stock
• Expiration – January
• Strike Price – 50
• Type – Put
• Price – $1.30 per contract
• Style – American
• Settlement Style – Physical shares
• Contract Multiplier – 100

How do we purchase the right to sell 1000 shares of XYZ stock for $50 in January?

Note: Total shares represented = quantity of options contracts x options contract multiplier = 10 x 100 = 1000)

You must first complete your transaction by paying $1,300 plus fees and commissions. This amount ($1,300) is considerably less than the margin required to sell 1000 shares short.

Before we choose to complete the transaction to purchase long puts, let’s look a bit further at the decisions we face before and on the contract’s expiration date:

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