Short Put vs. Long Put

Watch this short video to learn about the differences of Short Puts vs. Long Puts!

 

Transcription

Hey everyone, thanks for joining today’s video. Today, we’re going to be talking about short put options versus long put options and looking at the difference between short puts, meaning selling a put option or long puts, meaning buying put options.

This is going to be an introductory video as part of a series aimed at helping you understand some of the basics and foundational terminology you’ll need to know as you get comfortable learning about, talking about, and eventually trading options strategies. We’ll be looking at the difference between buying, also known as going long, and selling, also known as going short, as well as the difference between call options and put options.

 

I have the SPY ETF pulled up in the thinkorswim. This is the one year, one day chart, as well as some indicators down here. What we’re going to be doing right away is going into the trade tab. I did want to point out a couple basic things about the options chain before we actually go into selling versus buying. For today’s example, we’re going to be pulling up the seven day to expiration SPY option chain for January 2nd, 2024.

A couple of things about the option chain… For thinkorswim, you’re going to see calls on the left and you’re going to see puts on the right. In most trading platforms or options, this is going to be similar. This is the general user experience, but you can always customize things.

In my screen here for this option chain, I have a couple different columns.

I’m showing all strikes. The expiration date is in the middle, strike is in the middle, but I have open interest, the delta, bid and ask, going from left to right in calls and right to left on puts.

As far as options trading goes, volume is something that’s going to be important to look at. So for open interest, you’re going to see numbers here ranging from zeros to in the thousands. What this is telling you is at any one time for the January 2nd 475 call option, there are 3,581 contracts open at this very time. That’s important because you want to have liquidity in your options trading. Think about if you’re buying and you want to get out of a contract by selling. It’s going to be a lot easier to do that in the options that are trading in the thousands versus the options that have open interest in the zeros because no one’s interested in those options contracts.

The delta column… That’s going to be telling you at any given time here what the probability is of that options contract expiring in the money. If you’re going to be buying an options contract, you want it to expire in the money. If you’re going to be selling an options contract, you are going to want it to expire out of the money. You can see these ones are out of the money right now. In the dark shaded, in the purple shaded, these are currently in the money.

Just to point out one example here, if I were to be looking at the 29 Delta, this is the 479 strike that expires January 2nd. Right now, there is a 70 percent chance these will expire out of the money, and a 30 percent chance they will expire in the money. If you’re looking at some of the currently in the money options, looking at the 468, there is an 82 percent chance this will continue to be in the money at the expiration date of January 2nd. Conversely, there is an 18 percent chance this will fall out of the money before the January 2nd expiration date.

Bid and ask… If you’re clicking on an ask, that is going to bring up a single buy contract. If you’re looking at the bid, clicking on that bid is equated to selling that options contract. The difference between the bid price and the ask price is sometimes called the bid/ask spread. We want to be looking at options with a tight bid ask spread, so that we’re not giving up any of that value back to the market.

 

Let’s look at short put options versus long put options, so selling versus buying a put option here. We’re on the put side of the options chain. Let’s look at an at-the-money put option with a 474 strike price. Let’s look at buying that. That is at 42 Delta.

Let’s take a look at your maximum gain and your maximum loss before we actually graph this out. Your maximum loss here is going to be $195, that’s your premium that you’re paying for one of these contracts. Max profit is quite a bit higher than that.

I’m not going to send this, but let’s also analyze this trade on the analyze tab or the risk profile tab. Before I set things up, the Y axis here is going to be profit and loss in the thousands and the X axis is going to be the strike price. You always want to have the date at the top here set to the day after your options contract expires. Make sure that your break even is going to be that same day.

Right now what we’re seeing is about a 37 percent chance you’re going to break even on this trade with this break even price slice here. There is also a 63 percent chance you won’t break even on this, so you’ll lose money. When buying a put option, you are going to be taking a bearish bias on the security.

Let’s adjust things here a bit… You can see as the strike price drops, you could be gaining quite a bit of money. We’re looking at the teal line here. What you’ll see at this point, if it would go down to 430, you can see you would be making about $4,200 and you’re looking at this box right over here just to show you that. As I move on the x axis, it shows you your profit and loss dynamically. Again, max loss on this as the strike price goes up, you’re down $195 and that is it. The break even for this is actually going to be the strike price minus what you pay for the premium here.

 

Let’s look at what it would look like if you were going to be selling a put option contract. Again, bid is for sell, ask is for buy. Same at the money option here. Let’s take a look… $193 premium would be what you collect. So, your max profit here, conversely, is the premium collected. When you’re selling options, you’re kind of thinking about going about this as an insurance company collecting a premium. If something goes wrong for you, the insurance company, you could be paying out a lot. Your max loss, if you’re selling this uncovered, would be $47,000, or upwards of that. There are ways to cover this or hedge against this and we can get to that in different videos in the series. For now, let’s take a look at this graphed out here.

Everything is set up the same way here. Again, as you go left to right on the strikes, you can see dynamically the profit and loss here in this box. $193, that’s your maximum profit. Your maximum loss as the SPY ETF drops, you’re losing quite a bit of money. If it goes down to zero, highly unlikely, but that is your max loss of $47,000.

When selling a put option, you’re going to have a bullish bias and you’re going to want that ETF or that asset to go up. When buying a put option, you’re going to have a bearish bias and you want that asset to go down. Please check out our other videos in this series if you want to know what it looks like to sell a call versus buy a call or sell a put versus buy a call.

We go through all that with this link in the description below.