Long Put
Buying a put gives you the right to sell the underlying stock at the strike price any time until expiry.
Long Put
When you buy a put to open a position you are said to be "long a put". You can buy a put either to speculate or to protect a position.
Speculative Put
A speculative put is when you buy a put in hopes that the stock will fall, as opposed to buying a put to protect a position in the underlying stock.
Figure 7 shows the risk and return involved with buying a put (speculative put) with a strike price of $25 for a premium of $5. When you buy a put the most you can lose is the premium you pay for buying the put option. However you are able to make large profits if the underlying stock falls.
Figure 7.
If the price of the stock fell to $10 by the expiry date, the put option would have a value of $15 ($25 strike price that you could sell the stock for - $10 current stock price that you could buy the stock for). In this example the put holder would have a $10 profit ($15 the value of the option at expiry - $5 the premium paid for the option).
Protective Put
A protective put is when you have a position in the underlying stock and you buy a put to protect against a drop in the stock's price. A protective put is like buying an insurance policy on your stock to protect against the drop in price. You may want to buy a protective put if you think the underlying stock is going to rise buy you have some short term concerns, and you want to protect yourself in case there is a sharp drop in the stock price.
Figure 8 shows the risk and return involved with holding a stock and buying a protective put on it. When you buy a protective put you still have unlimited profit potential while you are able to limit your risk.
Figure 8.
If the price of the underlying stock fell to $25 or lower by the expiry date the combined position would have a loss of $10 (this remains the same because the profits on the put option will offset any losses on the stock below the $25 strike price). If the price of the underlying stock went up to $45 there would be a profit of $10 ($15 the gain on the stock - $5 the premium paid to buy the protective put).
A protective put has the same risk reward profile as buying a call option.
