Stock Option
Basics: The Long Put
By
David G. Ondercin, PhD
This is the third of four articles on the basic
elements that provide the foundation for all Option Trading. These elements
include: The Long Call, the Short Call, the Long Put, and the Short Put. By
combining Calls and Puts in creative fashions, Options traders are able to
generate income strategies and limit risk. This article introduces the third
such element, the Long Put.
Each element contains the prospects of
producing Cash Flow with a greater or lesser degree of risk. Like the Long Call,
the Long Put’s risk is limited to the purchase price of the Put. It is a bearish
strategy that anticipates that the stock or underlying security will decline in
value.
The Risk Graph below illustrates the risk of the Long Put:
Long Put
For those readers new to Option Trading, it takes a little adjustment to think
about Puts increasing in value as the underlying stock decreases in value. The
Long Put can be seen as a substitute for shorting the stock.
The risk associated with the Long Put is limited to the cost of buying the Put.
Contrast this with the risk of shorting the stock. The risk of shorting stock is
unlimited, or at least limited to how high the stock can go before you exit the
trade. So, if you buy 10 contracts of a $7 Put, your risk is limited to $7,000.
If you shorted the stock at $25 and it jumped to $50, your current risk is
$50,000 ($25,000 for the stock and $25,000 underwater).
The profit potential for the Long Put is good as long as the value of the stock
continues to decline. As the purchased Put goes In-the-Money, you gain $1 or
every point the stock decreases. The interesting, as well as, rewarding part of
trading short is that stocks seem to decrease in value much faster than they
increase in value. Your $7 Put Option can go to $10, 15, or $20 quickly. A
general rule of thumb is to buy Options at least three months away from
expiration in order to give you sufficient time to be right. It is not generally
advisable to buy near month Puts because unexpected market conditions could work
against you for a week or more, leaving you little time for the stock to move in
your direction.
A common strategy for Put or Call buyers is to purchase LEAPS® or long-term
Options that have expiration dates one to two years away. These long-term
Options provide the trader with plenty of opportunity to be right, and also time
to combine with other Option Strategies, such as, Married Puts and Calendar
Spreads to name just two.
A crucial aspect of directional Long Put trading requires the trader to
correctly anticipate that the stock or underlying security is about to decline.
Look for crucial areas of support on a chart that, if broken, will likely
continue to head downward. Examine both daily and weekly charts. Besides drawing
horizontal lines connecting support, also look for diagonal trendline
violations.
Learning Cash Flow Option trading using Calls and Puts is just a few
mouse-clicks away.
Optionsmentoring.com is all
about:
1) Teaching you to understand the risks before you place a trade;
2) Teaching you to properly put on the trade so that the odds are heavily in
your favor;
3) Teaching you how to make adjustments to your trade if it moves in one
direction or the other; 4) Providing you with sufficient detail to really
understand how to trade Option Strategies;
5) Coaching you for success; and
6) Providing you with free trade setups for several months on a weekly basis so
that you can generate regular cash flow.
Optionsmentoring.com is the place, and Trading Stock Options the Easy Way is
the course that can get you on the road to financial independence.
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