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Long Put
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| Risk: |
Limited |
| Reward: |
Limited to the initial cost of the Put option. |
| The Trade: |
Buy a Put. The more bearish your view the further out of the money you should go. |
ABC Stock trading at £5.00
Buy 1 Sep £4.50 call (see pay-off diagram below)
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| When to use: |
Very bearish preferably in the short term No other position gives you as much leveraged advantage in a falling stock/index (with limited downside risk). |
| Volatility expectation: |
Very bullish |
| Profit: |
Not unlimited because assets (stocks) can't fall below zero. But if you buy at the perfect time when volatility is low and the market crashes, profits of 1,000s% are obtainable. |
| Loss: |
Restricted to the premium paid |
| Breakeven: |
Reached when the underlying falls below the strike price by the same amount as the premium paid to establish the position. |
| Time decay: |
This position is a wasting asset. As time passes, value of position erodes toward expiration value. If volatility increases, erosion slows, if volatility decreases, erosion speeds up. |
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Trading ideas and tactics:
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- Consider mixing it up, maybe look to buy puts with different strikes
- Watch that volatility. If the market has already tumbled then chances are that by going long puts you've missed the boat as you'll be buying very expensive options
- If you're bearish try and buy them on rallies in a downtrend
- Buying puts is normally a bad way to hedge stock risk because they are a wasting asset. For example if you are long ABC stock and buy a put and the share doesn't move lower you will lose money, and that's not hedging
- A better hedge would be to use CFDs to sell short the shares you own
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