Long Put Option

The Long Put option is the easiest bearish strategy. It’s one of the most common options trades due to the protective nature of the put. You can get a year long ‘black-swan’ insurance for a few hundred dollars or less. The put gives you the right but not the obligation to sell the stock for a pre-determined price.

However, this is an options trading blog so you won’t be selling any stock. You’ll just sell the put for profit!

Exercising the put involves buying shares and losing extrinsic value. It’s never a good idea to add complexity to something meant to be simple.

I’d suggest to keep tabs on it at least once per day. Options can gain or lose value fairly quickly so don’t just set and forget about it.

Put options tend to expire worthless more often than not. In fact around 70% of all options expire worthless. You need to have a very strong conviction of a sharp decrease in the share price. Don’t forget that you have to recover the money you paid too.

The Long Put is set-up by sending a buy order for 1 put options contract at your chosen strike. You get a theoretically substantial profit potential for a limited loss:

long put option
Payoff at expiration of an at-the-money $50 strike put option in a theoretical stock trading for $50

Long Put Option Delta

There are no hard rules about the option’s Delta. However, the probability of profit will increase the closer your strike is to the money. Unfortunately, the price of the put will be higher too.

On balance something like -30 Delta is expected to be more profitable than -5 Delta. Note that unlike the long call the Delta is negative. This is because we’re long the put but we’re short directionally.

A different way to explain it is with the stock itself. Each share has 1 static Delta so if I short sell 1 share I’ll get a Delta of -1. Consequently we are supposed to get more Deltas when the put goes in the money. Let’s say the theoretical stock tanks to $1, we’re supposed to have something like 90 Deltas. However, we get -90 since we’re directionally short.

The Long Put Delta becomes more and more negative as goes in the money.

Gamma

You’re long Gamma which gives you the same compounding effect as a long call. I know it sounds a bit counterintuitive, how come we have positive Gamma and negative Delta. Let’s just say it means we get more Delta as the stock depreciates.

Don’t worry, some of the things I’m writing about didn’t make any sense when I started. But over time you begin to understand them and options start growing on you. It just takes a bit of time and effort like anything else.

Let’s say you have a -30 Delta option with a Gamma of 3. A $2 down move will give you 6 additional Deltas. We end up with -36 Delta.

Gamma increases the closer you get to expiration. Fair warning, you won’t get rich by buying cheap weekly puts! Ok, you may but it’s highly improbable.

Gamma
long call option
long put option
DTE 1 means 365 days, thus 0.1 means 36.5 days. The plot includes both puts and calls

So do you buy a longer expiration to take advantage of time or a shorter one to buy cheap Gamma?

The answer is the same as if you were buying a long call. You pay for the high Gamma with high time decay, hence the fair warning above.

Options are all about planning and giving yourself the best chance of success. We don’t want to turn this into a casino by shooting random darts. Remember that these things expire at some point.

Some traders like to buy a bunch of penny stocks. That’s not my favourite strategy but there’s at least one advantage compared to doing the same thing with options. You keep the shares forever, or at least until the companies go bust.

Vega

You’re long Vega so you have two revenue streams: share price depreciation and volatility increase, again similar to the long call. Therefore, it’s best to purchase the put when Implied Volatility (IV) is low. Sadly, this condition is likely to be met before a sharp down move.

Volatility represents fear so it’s natural that market participants will be affected when their shares are getting hammered. Our problem is that we have to predict when this may happen with at least some level of temporal accuracy. Nevertheless, it’s still better than day trading based on 15 minute candlesticks, you have weeks ahead.

Moving on to an example on the effect of Vega.

The theoretical stock is trading for $50 and you buy a $50 call at an IV of 50% for $3.08. The stock goes down to $48 10 days later. However, the IV goes down to 40% and your option is now worth $3.20. You made $0.12 (total of $12) even though the Long Put is in the money.

In the opposite scenario where the volatility went up to 60% the Long Put appreciates to $4.17. We’re up $1.09 (or $109).

That’s why you buy a put before the share price goes down and the volatility spikes, not after.

Vanna

Volatility and Theta work the same for long calls and puts so if the IV is high your time decay will be high.

The Long Put option’s Delta will become more negative as IV increases because of Vanna, a second-order derivative. It’s responsible for the relationship between Delta and Vega and all the more reason to buy when the IV rank is low. The ‘buy low sell high’ rule stands.

Purchasing far out of the money Long Put options prior to earnings announcements remains a bad idea. The IV crush will render your position worthless.

You can still buy a long duration put in the post-earnings cycles, it will be affected less.

Theta

Time decay is your worst enemy once again! It starts to gain traction around 60-70 days prior to expiration and explodes the last 20 days.

There are a lot of similarities between the long call and the long put’s second-order derivatives and the expected move of the stock so I haven’t changed the text below. You can skip it if you’ve read the long call page.

The second-order derivatives in question are Charm and DvegaDtime. We can go on forever, till the 8th-order derivative and beyond, but we’ll settle for these for practical reasons. You’re not a market maker otherwise you wouldn’t be reading this.

Charm a.k.a. Delta bleed is pretty straight forward, you lose a small bit of the option’s Delta as each day goes by. It’s understandable that your Gamma will bleed too.

They say that everything disappears in the ashes of time so DvegaDtime will chew up your Vega.

You don’t need to calculate these but you’ll notice them for sure, I promise. They are all connected and work against you in sync while your option is out of the money.

It works differently when the option is in the money. We won’t discuss that because I assume it won’t matter since you’ll sell the Long Put Option for profit.

A stock’s expected move

Here’s how it works. Imagine the time cone of the stock’s expected move. I’d anticipate a wider range over 252 days compared to 40 because of the longer period of uncertainty. Who knows what may or may not happen?

Let’s try to visualise this with a Monte Carlo simulation. This is the expected move of SPY over the next 40 trading days on the left and 252 on the right:

expected move
long put option
long call option
expected move
long call option
long put option

You can see that the 252 day range is indeed much wider. However, as time goes by the range will become narrower because events will move from the future into the present and then the past (or the other way around).

This makes some future paths less and less probable because the market adjusts its expectations based on the realised one. For example, there is a 53% probability that SPY will increase in value tomorrow and 47% that it will decrease. The realised probabilities will be 1 and 0 once the event has moved to the past.

So if the stock trades flat the time cone will get narrower as time goes by. Your out of the money Long Put option will move further and further away from the money. I could argue that the time cone will be moving away from the put but this is pointless because you’ll lose your premium either way.

Long Put option management

There is not a lot to manage since we have a single leg. You can let it expire worthless, just prepare mentally at the time of purchase.

Some traders choose to close it to retain a bit of premium. The downside is that you may close it for a loss prior to a trend reversal.

Long Put options are a great way to be directionally short the underlying stock. First, you don’t need to come up with 150% margin. Second, you can’t become the victim of hard to borrow fees. Note that hard to borrow fees are opaque, arbitrary and can increase to eyewatering figures with little or no notice. Third and most important, your loss is limited.

The last point is very important, you may have heard of a few funds which suffered substantial losses during the GME short squeeze.