Options Strategies: Long Put Spread

Options Strategies: Long Put Spread

Option Strategies

Summary:  With a long put spread, you can anticipate a decline in the underlying value with a limited investment. While profits are capped, they are still very attractive


What is it?

A purchased put option gives the right to sell an underlying asset for a certain amount. When you write a put, you enter into an obligation to purchase.

These two trades can be combined, by buying a put (and getting a right) and at the same time selling a put with a lower strike price (take-down obligation). This is widely used and this is called a long put spread.

Why would you want to buy this?

Suppose you expect a certain stock to fall, but not indefinitely. The expected decline is a reason to buy a put, but why not take a purchase obligation at a lower level? After all, you do not expect the share to fall to € 0 and you will receive money for the obligation you enter into. In short, you reduce your investment.

Spreads have a maturity and this can vary from a few days to a few years. What you also want to know in advance is the price at which you can sell the share and for which you may have to buy. These are called the strike prices of the option and in the example below the strike prices are $140 (your right to sell) and $120 (your purchase obligation).

Example:

Let's take a look at the Apple stock. The share is currently trading around $145 and you expect a decline. You expect the share to fall towards $125 and you would like to take advantage of that. You decide to do this by buying the $125-$135 put spread.

You buy the 135 put for $7.20

You sell the 125 Put for $4.45

Example of a profit/loss chart of a long put spread from SaxoTraderGo

On balance you pay $2.75 and if your expectation comes true – the share falls towards $125– the sales right on $135 must be worth at least $10 and the purchase obligation on $125 is then worth zero.

On balance, the spread will then increase to a maximum value of $10. You can easily determine this yourself by checking what your position actually is. You may sell at $135, but you must decrease at $125. The difference between these is $10, which is also the maximum value of the spread. But you only paid $2.75 for this and you therefore make a 360% return if you saw it correctly.

When are you happy with this spread?

If the stock drops below $135. You have the right to sell at $135 and you may have to take down at $135 and you paid $2.75 for that. So you make a profit from $132.25 and lower. Optimal is, of course, a drop below $125, because then the spread will reach its maximum value.

When are you not happy?

If the stock goes up because then both options become worthless. Because who has money left over on the expiry date for a right to sell at 135 if the share can be sold on the stock exchange for $145? Exactly, nobody

When do you buy a put spread?

You buy a put spread if you think the underlying asset will fall in the coming period. You buy a put spread because the investment is smaller than just buying the put. You also sell a put and that reduces the investment. The disadvantage of this is that you maximize the chances of winning

When will you sell the purchased put spread?

You know that the maximum value of this put spread is $10. The spread will reach this value if the share is below $125 at the expiry date. But you may well be satisfied if your investment (almost) doubles to $5.50.

Perhaps the following rule of thumb can help you. Sell the spread when it trades at about 80% of its maximum value. In the case of this put spread, that would mean buying the spread at $2.75 which can be worth up to $10.00. 80% of$10 is $8. This would mean that if you can sell the spread at $8 you will have almost a 300% return.

What is your maximum risk?

The risk you run when buying the put spread is the premium you have paid. That is your maximum loss and will occur if the stock expires above the strike price you bought. In this case, it is above $135 But you can never lose more than the option premium you paid.

In short

You buy a put spread if you think the underlying asset is going to fall. You will make a great return if the expected decline actually takes place. Returns of more than 100% are then very possible.

Your maximum risk is also known in advance and that is the price you paid for the put spread. That is the maximum amount you can lose.

Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.