07 Common operations in a bear market Short selling VS buying Put

In the previous video, we learned about the common options trading strategy of buying a call (Long call).

Today, let's understand the second common strategy: buying a put (Long put).

If you expect the stock price to fall, you can short sell the stock or buy its put options.

Short selling refers to borrowing some stocks first (i.e., margin trading), selling them on the market, and then buying back the same amount of stocks from the market after a period of time.

The difference between the selling price and the buying price, minus the interest from margin trading, is the profit from short selling stocks.

Compared to going long, short selling is a strategy that carries higher risks and costs.

Firstly, short selling requires maintaining a certain margin ratio.

When your account margin is insufficient, due to risk control considerations, the brokerage may carry out forced liquidation.

In addition, stock prices may rise instead of fall. For example, if you short sell a stock at a price of one thousand US dollars, when you buy it back, you may need to pay thousands of dollars, or even more for it.

Therefore, the biggest risk of short selling is the potential for unlimited losses.

By buying put options, you can gain a certain level of flexibility.

Firstly, options have leverage. The cost of buying options is often much less than trading stocks directly.

Furthermore, since buying put options establishes a 'long position', the buyer's potential maximum loss is limited to the option premium paid.

Therefore, the maximum loss when buying put options is actually controllable.

Of course, options are a relatively complex investment tool and may not be suitable for all investors. It requires traders to determine not only the market direction, but also the timing.

Next, let's introduce the key points of the 'buying put options' strategy.

Taking an options chain as an example, here is a put option with a strike price of $52 and an option premium of $1.89.

The contract multiplier for US stock options is 100.

Therefore, to purchase one contract of the put option, you need to pay $189 ($1.89 x 100).

Now, let's take a look at the profit and loss analysis chart for buying put options at the expiration date:

The worst-case scenario of buying put options is when the stock price is higher than or equal to the strike price on the expiration date, rendering the put option worthless and resulting in a maximum loss equal to the option premium paid.

For simplicity, we will not take into account commissions and other transaction fees here.

If the stock price falls below the strike price, then the put option has intrinsic value, which is calculated as the strike price minus the stock price.

However, if the stock price drop is not significant, there may still be losses because the premium was paid when buying the put option.

In other words, the breakeven point for buying put options occurs when: spot price = strike price - option premium.

As the spot price falls below the breakeven point, the investment returns begin to turn positive.

However, considering that the spot price theoretically cannot fall below zero, the potential maximum profit from buying put options is limited, with the maximum profit being = strike price - option premium.

To summarize, buying put options and holding until expiration, investment gains and losses can be divided into three scenarios:

First, if the spot price ≥ strike price, the put option becomes worthless, having no value, therefore the maximum loss is the option premium paid;

Second, if the breakeven point ≤ spot price < strike price, the put option has intrinsic value, but this value is not sufficient to cover the option premium paid, resulting in partial losses;

Third, if the spot price < breakeven point, the put option's intrinsic value exceeds the option premium paid, leading to positive investment returns. However, similar to short selling a stock, the maximum profit from buying put options is limited because the spot price cannot fall below zero.

Remember, there is no need to hold options until expiration.

Because time value is an important component of options value. Generally speaking, as the expiration date approaches, the time value will gradually decrease.

Alright~ The content of the options introductory course has been covered up to this point.

If you are interested in our course, please follow us, we will bring you more exciting content in the future!

See you next time!