Nearly 100 pages of Option Trading subjects and strategy graphs:

• Why Trade Stock Options?
• The Basics of Stock Options
• How to: Trading Stock Options
• How to read Option Graphs
• Option Trading Strategies by Outlook
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  • All Bull Call debit spread graphs
  • All Bull Put credit spread graphs
  • All Bear Call credit spread graphs
  • All Bear Put debit spread graphs
• How to: Diagonal Spreads
• Choosing a long option Strike Price
• Choosing an Option Expiration date
• Pyramid In or Average Out? : Option Buying Strategies, Option Selling Strategies
• Covered Call Strategies Disadvantages
• Percent to Double
• ETF Trading with Options
• Free Rides: Guaranteed Winning Trading Strategies?
• Delta-Neutral Trading Explained
• Stock Repair Strategy
• Stock Enhancement
• The Option Greeks
• Option Terms
• Trading Rules, Tips, Techniques
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Option Strategy of the Week

Strategy: Long Put, Out-of-the-Money

The Outlook: Extremely bearish. At expiration, the stock must have fallen to the OTM strike price, plus the initial debit, just for the option to break even. It must have fallen more for the option to show a profit.

The Trade: buy put(s), using the next strike price below the current stock price.

Gains when: stock falls enough by the expiration date to overcome the lower strike price and the initial debit.

Maximum Gain: limited only by the stock price falling to zero.

Loses when: stock goes up, does not fall, or does not fall enough by the expiration date.

Maximum Loss : limited to the initial debit.

Breakeven Calculation: Strike Price bought - Initial Debit.

Advantages compared to short stock: much less capital required, vastly increased leverage, "built-in" stop loss.

Disadvantages compared to short stock: much greater risk of 100% loss of the capital invested, limited life, more stock movement needed to be profitable.

Volatility: after entry, increasing implied volatility is positive.

Time: after entry, the passage of time is negative.

Margin Requirement : None. Initial debit must be paid in full.

Variations: Long Put, ITM; Long Put ATM.

Synthetic Equivalent: Short Stock plus Long Call at the strike used for the OTM Put.

Comments

• Buying an Out-of-the-Money put is the least expensive long put, and the least likely to show a gain at expiration.

• OTM long puts are used by speculators expecting a quick downward move in a stock. A speculator who gets the timing right can double his investment in a day or two.

• OTM long puts can be used to trade against suspected overenthusiasm or "blow-off tops" in a stock or index ETF, at much less risk than shorting the stock or ETF. If the speculator really is catching the top, the percentage gains can be substantial.

• OTM long puts can be used to speculate on possible big downward moves at earnings time. If the speculator is correct, large percentage gains are possible. If wrong, the dollar loss is relatively low and limited.

• Like all long options, OTM long puts have a "built-in" stop loss. You can only lose as much as the put cost.

• A trader wanting a better probability of the option ending up In-the-Money might want to use ATM puts instead. A trader wanting the best probability of a gain nearly dollar-for-dollar with a drop in a stock might want to use ITM puts instead. See the ITM, ATM, OTM? page for more information.

Exits

• Since this is an extremely bearish position, the trader is obviously expecting the stock to drop quite a bit. If the stock does not drop far enough, and the time to expiration gets to just a couple weeks, it is usually wise to exit the trade, taking less than the maximum possible loss.

• However, since this is a very low cost and speculative position in the first place, it is not inconsistent with that strategy to just hold on until expiration. Just like gambling, every once in a while there might be a big winner if you stay in the game.

• If the stock drops as expected, speculators usually take gains by selling the put. However, they can also roll out to a later month, or exercise the put to sell or sell short the stock at the strike price.

Adjustments

• Since a long put is a component of many other option strategies, a long put position can sometimes be adjusted or converted to those strategies.