Long Put Options vs Short Put Options vs Protective Put Options Trading Strategy
Long Put:
A long put strategy is a bearish investment approach in the options market. When traders believe that underlying will fall faster and volatility will remain higher or increase, they buy put options, it is called long put.
When we buy a specifit put options contract, it gives us a right to sell of the underlying at a specific price (strike price) but not the obligation by a certain time (expiry).
This is different from selling a stock or future, a long put mean you are essentially betting that the stock price will fall.
Pros:
Limited Risk: Risk is limited for the buyers, maximum loss is only the premium paid by the buyer.
Leverage & Short Position Carry: Buying put options reffer the right to sell a fixed number of underlying, but when you are selling the stocks it need huge margin plus you cant carry only equity short position overnight. But while you are buying a put options you are pauing a small amount of premium besides you can carry the put options until expire.
Lower Upfront Capital: Even if we compare with a future contract selling, put options buying requires less capital.
Cons:
Time Decay: The value of a put option decreases over time, even if the stock price stays flat. This is called time decay. Sometimes value of the put options may decrease even if the falling but slowly, normally this thing happen with ATM and OTM put options. Mostly ATM and OTM buyer faced this risk of losing money even if the stock falling slowly.
Unexercised options expire worthless: If the stock price doesn't fall below the strike price by expiration, your put option expires worthless, you will lose entire premium.
Huge Penalty If Expires As ITM: If your long put options become in the money at expiry and you forget to close your position manually, then either you have to give payout of the underlying or a huge penaly will be charged in case of stocks options. In case of index options you have pay only higher STT.
When To Buy A Put Options
Traders purchased put options when they believe that the price of the underlying will fall sharp, they wait for perfect technical scenario or negative news before they long put options.
Today we will discuss the probable best technical scenarios so that our readers can understand easily.
Buying After High Volume Fall Followed by Low Volume Re-Test
This si sthe best price action trading strategy for a long put, after this scenario buyers of the put options can easily ignore options greeks, options chain and open interest data impact in options premium. Normally greeks, and open interest data follows the technical scenario. So traders gain an extra advantage when there is a high volume and big candle decline and low volume retest and then any technical selling scenario (like trend breakdown) occur in chart pattern.
Exhibit 1
Now trader wait and watch how it re-tests its previous swing high. If the previous swing high re-tests with small candles or mixed color candles and with lower volume then it indicates that the buying is not belongs to the professionals.
After this any technical selling scenario is the most perfect put buying opportunity for the traders.
Buying when a Shooting Star Occur After a Sharp Fall:
A shooting star is always good selling scenario, but when a shooting star occur during a rally with normal candle after a high volume decline is the best selling opportunity considered by the professional traders.
Some traders buy put options immediately while professionals wait after converting the chart into lower timeframe.
After receving any other selling signal in lower timeframe chart professional execute theirs trade.
Professional believe, alone Shooting star is not enought to trade, so they need another confirmation in lower timeframe chart.
Exhibit 2
Buying put options after an out side gap up opening but negative closing with more than the normal volume
Exhibit 3
In the left side picture, upward momentum may occur both in up or down trend. In this scenario trend is not a factor.
If an outside gap up opening occur and finally price close negatively with bigger than the normal volume and big size red candle, somehow investors lose the confident for further up move and start selling their holding.
If the candle boceome very bearish then formation we can found is a dark cloud cover or bearish engulfing or total bearish engulfing.
Here pattern is not important but the psychology. Traders lose confidence. This is the perfect scenario for put long.
There are many more one after another great put buying technical scenarios available, in my other article I will try to mention those if I receive feedback from my readers end.
Strike Selection:
As I mentioned earlier that put buyers may lose money if the underlying fall slower than you expect, therefore the strike selection is more important part for put long. I personally always prefer deep ITM put options, Delta with at least 0.8.
Breakeven:
Breakeven Point = Strike Price - Premium paid
Assume you have purchased a put options of ABC Ltd, strike price 520.00 and you have paid a premium of 20.00/- if you hold it till the expiry day and want to get back your own investment then ABC Ltd shall trade at 520-20=500 on the expiry date.
Why People Lose Money:
People lose money because either bad timing in direction, mean after a few days significant decline in stock price, when it is trying to be stabelize, common traders found the premium is cheaper than few days and buy with a hope of further fall. Or they lose money due to time value decay. Hold the long put options though the move is very slow or going opposite direction.Many people lose money only for buying far OTM put options, though underlying price goes in favour of their direction but due to OTM they may lose money.
Maximum Loss:
For long put maximum loss is the premium paid. For example, assume you have purchased 500PE of ABC Ltd and paid a premium of 7/- and the lot size is 800, if the stock move up you will lose money. But not more than the 7/- *800 you have paid.
Maximum Profit:
Maximum profit is unlimited, the more parice will fall below the breakeven level the more you will ake profit.
Short Put Options
Short put options is a bullish trading strategy, traders use when they belive underlyign will go up but slowly and volatility will remain low.
Some traders short put options to gain the unusual time value remaining in the options premium.
Seller of a put options has obligations to buy the underlying in exchange of receving the payment in advanced.
This is different than directly buying a stock, mean you are actually betting that the stock price will move up.
Pros:
Profiting from less volatile market: When underlying price creates any buying opportunity in weak up trend but volatility is very less, that time premium of a cal options do not rise properly, so buyers of the call and put options both lose money. This time traders show their bullishness by selling put options.
Cons:
Unlimited Risk:
Options selles have unlimited risk and limited profits
Huge Margine:
As options writers have unlimited risk, therefore a huge upfront margin collected by the broker
When to sell a put options
Put options selling has unlimited risk, therefore always carefully chaeck the chart several times, check the trend and volatility. While underlying trend is up and approaching a demand or creating technical buying opportunity with less volatility, traders focus to make money from selling put options.
Traders Consider The Below Points Before Selling A Put Options
- Trend is mildly up
- Underlyign approaching demand
- Underluing creating supply
- Broader market is also in up trend and creating demand or approaching demand
- Implied Volatility of the underlying is less than usual
There are many more technical scenario when you can sell put options, in future I will discuss gradually.
Breakeven = Strike Price - Premium Received
Maximum Loss: Unlimited
Maximum Profit: Premium received for the write
Strike Selection: First of all identify the stop loss of the underlying, assume the stop loss 302. and the nearest strike price put options is 300 then shorting 300PE will be less risky than other strike price.
Why people lose money:
There are many reason why people lose money after selling put options
- Selling put options at supply
- Selling put options in high volatile market and on event day
- Selling put options in down trend
- Bad timing
Protective Put Options (Synthetic Long Put)
Protective put options is known as synthetic put also, when an investor own a stock and woried about downside risk due to some event in near future, that time they hedge their long equity position with long put, this what we call protective put.
The put options actually protecting portfolio valuation from downside risk.
If your Equity long fall that will give you loss where put options wil gives you profit, thus your portfolio valuation will be balanced.
How it work:
You have existing equity position or entered into a new equity position, at the same time you have purchased put options of the same underlying. Now if the stock rises sharply then you will make money from equity but lose money from options, though the options capped your equity profit partially yet you can make some profit from sharp movement.
Secondly if underlying fall, you will lose money from equity and your put options will give you profit. Thus your losses will be limited.
Things to consider:
The startegy require huge upfront margin, as you are buying stocks and paying premium for the put options.
Secondly your profit will be limited even if trade goes towards your direction.
Example:
Assume you have purchased 250 qty of ABC Ltd @ 500, at the same time you are woried about down side risk and so covered with a long put, assume you have purchased 480PE @ 20 lot size 800, Now if the stock fall by 20 rupee you will lose 5000/- but at the same time your put options premium will rise and it reach 26, so you will earn 4800/- from put, thus you will limited your downside risk.