Options Tutorial: Long Put, Short Put & Protective Put Options Trading Strategy

In this Options Trading Course I will Explain Long Put, Short Put & Protective Put options Trading Strategy In Depth Using My Best Knowledge. I Will Try To Explain Everything In Very Simple Manner. This Simple And In-depth Explanation Will Help Both The Beginners And Experienced Traders.

Long Put

Short Put

Protective Put

Long Put: Mechanics, Timing, Risk & Reward, Managing Positions

A Long Put option strategy gives you the right, but not the obligation, to sell a stock at a predetermined price (strike price) by a specific expiry date. You profit if the stock price falls below the strike price by expiry. When you buy a put options you are actually assuming that you are selling the underlying at your strike price.

Let me make it clear mainly for the new traders.
Suppose an ABC Ltd is trading at 500/- and you are bearish on it. In options market there are many bearish strategy but buying only put options mean you are highly bearish and expecting a sharp fall in the underlying

long_put_options_strategy_explained_by_dronakul

If you buy a put options it means you have the right to sell the underlying at the strike price. If you buy 500PE of the ABC Ltd, it gives you the right to sell the underlying at 500 on expiry.

After you purchase the put options three outcomes are possible.

1) Underlying fall below 500/- and the options become ITM, you can book profit of your long options or you can inform the exchange that you want to give a payout of the security (ABC Ltd.'s share) if you are holding the underlying in your demat and feel the underlying may fall more. This is your right to sell at specific price.

2) Underlying rise and trading far above 500/- and the options become OTM, you can let the options expire, do not sell it at your end, if you sell you have to pay the brokerage and taxes, but if you let the OTM expire, you have to pay nothing. By the way, currently the underlying trading above 500/-, but if you wish you can inform the exchange that you want to give a payout (Which is called exercise in options term) of ABC Ltd from your DP, if you do so you are actually loosing more money. As the ABC Ltd trading above 500/- you can sell at the market price. But it is your stock, if you wish you can give a payout at a loss.
3) The underlying may expire at 500/-, the put options will become zero, and again, if you wish, you can give a payout of your holding to exchange at your strike price (here 500).

So if you buy a put options, you will have a right to sell the underlying at the strike price.

Remember in India, if you buy a stock put options and the put options expires as ITM by any amount, it will be under compulsory delivery contract, so before expiry do not forget to close your options position. If you fail to sell it then mandatorily you have to give payout (exercise) of the underlying security, equivalent quantity of the lot size, in case of failure you have to pay a huge penalty. In case of Index options, only higher STT you have to pay as a penalty.

Buying put options mean you are highly bearish on the underlying.

Positive side of buying a put options

Limited risk unlimited reward: Put options buyer's risk is limited, if the trade goes wrong, the buyer can lose only the premium he has paid. On the other side, if the trade goes in favour of you, mean if the underlying fall sharply, your options premium may rise a few times.

Leverage: In terms of return on investment (ROI) buying put options is the best strategy when you are bearish, due to leverage option's ROI is much more than any other trading instrument.

Utilise of Downtrend: When the entire market is in down trend, equity trading become tough, that time buying put options is more effective.

Negative side of buying a put options

Time value decay: You will lose money due to time value decay if your view just little bit incorrect. You are strongly bearish in the market but if the underlying falling very slowly or shows a zig zag behaviour, like one day up another day down, in that case the options premium will comedown even if the underlying fall below your strike price and you may lose money.

Which points shall I consider before buying a put options:

There are many points to be consider before you buy a put options.

1) You must check the trend, buying a put in down trend is preferred for the beginners.

2) Check the demand supply of the underlying, never buy a put options near or at the demand.

3) Check the broader market for additional confirmation of bearishness.

4) Check the maximum risk and maximum reward.

5) Check the options chain for open interest (OI) data. If you notice, OI is unwinding at or near supply of a put options or OI is building up of a call options at or near the supply is a bearish signal.

6) Select the strike price properly, less time value in options premium is better for the options buyers, in options premium, intrinsic value : time value ≥ 3:1 is preferred one.

7) Check the liquidity, some options contract has less liquidity and those are very tough to trade.

When to buy a put options

To trade effectively in options market, knowledge of technical analysis is more important than options chain, open interest data, put call ratio data or options Greeks analysis. Below mentioned technical scenarios are good for options buyers.

1) Larger timeframe trend is down and price approaching shorter timeframe supply zone. i.e. daily trend is down and price approaching hourly or 15 minutes supply zone.

2) In larger timeframe price fall with one very big red candle and now approaching the top of the same candle.

3) In larger time frame down trend, price creating bearish reversal pattern (like, short CMO, evening star, bearish engulfing, EOR pattern, dark cloud cover with rain drop, shooting star etc) in lower timeframe.

4) A perfect trendline breakdown.

As you will gain more experience, you will learn to use the above scenario more effectively.

The below point to be consider:

Maximum loss= The premium paid

Maximum profit= Unlimited

Breakeven Price= Strike price - Premium paid

Example:

Assume ABC Ltd trading at 500/- and you are bearish on it so you have purchased 500PE and paid a premium of 12/-

If the stock expire at or above 500 you will lose entire 12/-

Your breakeven point= 500 -12

= 488

It means, if the underlying close below 488 then only your profit will start. How to eliminate this risk?

ATM and OTM options has 100% time value try to select the strike price which has merely 25% time value of the options premium.

Short Put options strategy:

A Short Put option strategy involves selling a put option contract and collecting a premium upfront. You are obligated to buy the stock at the strike price if the buyer exercises the option by expiry.

Selling a put options mean you have a bullish or neutral view on the underlying.

Consider the below points:

When you sell a put options, you receive the premium.

For selling a put options you have to pay higher margin as your risk is unlimited.

You have obligation to buy the underlying at your strike price if the stock expire ITM.

short_put_options_strategy_explained_by_dronakul

What Are The Outcomes Of Selling A Put Options

1) Underlying move up above your strike price. As the Premium of a put options is inversely proportionate with the underlying. If the underlying fall, put of the premium will rise and vise versa, The intrinsic value of the option will be zero at expiry, but you may still keep the premium received when selling.

2) Underlying expire at your strike price. The options premium will become zero as it has no intrinsic value. You can keep the premium you have received.

3) Underlying expire below your strike price. This time the remaining intrinsic value will be options premium, and you shall buy the options back before the market close, or else you will be obligated to buy the stocks at your strike price.

Which Thing Shall I consider Before I Short A Put Options

1) Check the trend, price is in up trend and approaching the demand zone.

2) Check the broader market for additional confirmation that there is no sign of bearishness.

3) Check the demand supply of the underlying, never sell a put at supply.

4) Check the maximum profit loss and breakeven point.

5) Check the implied volatility whether is less than the normal or not.

6) Check options chain for open interest data, at demand Open Interest builds up of put options and unwinding for call options is better for selling a put options.

7) Check the liquidity of the options, illiquid options are tough to trade.

When To Sell A Put Options

Options trading depends more on technical analysis than options data analysis. Below mentioned technical scenarios are good for options selling.

1) Higher timeframe trend is up and price approaching a lower time frame demand but implied volatility is less than the normal.

2) Up and down, both trend are weak, technically bullish pattern formed like piercing pattern, morning star, bullish engulfing, long CMO, bullish hammer pattern etc.

As you will gain more experience you will able to trade more perfectly.

Maximum Profit= Premium received

Maximum loss= Unlimited

BreakevenPrice= Strike price - Premium paid

Example:

Assume ABC Ltd is trading at 500/- and you are neutral to bullish on it, so you sold ABC Ltd 500PE and received a premium 12/-

On the expiry if ABC Ltd close at or above 500, the premium of the 500PE will become zero and you will keep the entire premium of 12/-

If ABC Ltd trade below 500/- before closing then you should buy the options you have sold to avoid the obligation of buying the stocks.

Breakeven point is 500-12=488, for every 1/- decline in the underlying you will lose 1/-

Protective Put Options Trading Strategy

A Protective Put Option Strategy is a hedging technique used to limit potential losses on an existing stock holding (long position). It involves buying a put option contract with a strike price below your current stock price.

If we do hedge every time we hold a stock, then making money from trading will be almost next to impossible. Because if we hedge against our equity long every time then when stock will move up we will make money from equity but lose from put options.

This strategy is applicable before the big events. Assume you are very bullish on some stocks and already you have it i your portfolio, now there are some big event like Union Budget, Election Result, Monetary Policies etc are awaiting and you are afraid of event impact. In this types of situation you can look for protective put options for your portfolio to minimize downside risk of your portfolio due to event.

Strike Selection:

For protective put options strategy strike selection for neutral hedge is important. First identify rule based stop loss of the underlying stocks as per technical analysis and select the strike near stop loss price. i.e. ABC Ltd currently trading at 500/-, rule based stop loss as per technical analysis is 482, so buy 480PE for neutral hedge.

Quantity measurement:

Question is how many lots of Put options shall I buy for a neutral hedge? To quantify you should check the Delta of that particular strike price. Assume here the Delta of ABC Ltd 480PE = 0.32, and the lot size of ABC Ltd is 1400. For every 1 lot put buying, your equity quantity should be 1400*0.32=448, here we need to multiply the Delta and the lot size to calculate how many shares to options required for a neutral hedge.

Points to be remember:

Professionals apply this strategy mostly before the events.

Apply this strategy only a few days, once the event is over and the impact is clear you shall decide your holding.

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