Long Stock vs. Short Puts
May 23, 2018
While traders can be instinctive and act quickly when necessary, most of us try to analyze a potential position from all possible angles in order to fully understand the potential rewards and risks represented by the exposure.
During this analysis, we may also consider other underlyings, or other positions within the same underlying, that may be preferred over the structure we are considering.
If you’ve previously explored alternatives to long stock, a recent episode of Market Measures may help you further evaluate alternatives to this traditional position. The focus of the show is a side-by-side comparison of long stock vs. a short put.
Obviously, when a trader purchases stock, he/she is hoping that the value of the underlying will increase. For situations in which a trader is expecting a sharp rise in the price of the underlying in the near-term, long stock is certainly one choice available to the trader.
However, there may be situations when different position structures, such short puts, may better fit your outlook and risk profile.
As a reminder, the risk to a long stock position is that the underlying drops (possibly precipitously) and that the trade incurs losses. After such a drop, a decision must be made whether to hold the stock or to cut one's losses and close the position.
When selling puts, the trader is also at risk of getting long stock. If the strike of a short put is breached, and the options are exercised, the short put seller must purchase 100 shares of stock at the strike price for every contract sold.
In this regard, both a long stock position and a short put position, can ultimately end up as the same exposure (long stock). Sizing is therefore extremely important for option sellers because the addition of each contract represents another 100 shares at risk. Aside from a down move in the underlying, short puts can also lose money if implied volatility rises.
But what if a trader envisions a stock sitting still for the foreseeable future? Or at least expects it to trade in a relatively tight range.
In that hypothetical scenario, a trader might consider selling puts as opposed to buying stock, because it may produce a more attractive return on capital for the expected circumstances. Obviously, a long stock position that sits still at best breaks even. A short put under the same conditions can work perfectly, with similar overall exposure (assuming correct sizing).
A short put also comes with a buffer built into the position - that being the premium received from the option sale. For example, if stock QRS is trading for $33, and a trader sells the $30 put with 45 days-to-expiration for $1.50, the position breaks even if QRS drops to $28.50.
On the other hand, if the trader purchased long stock for $33/share in QRS, and the stock drops to $28.50, the trader will lose money all the way down.
One should also keep in mind the reverse situation - if QRS rallies. Under that hypothetical scenario, the long stock position does offer additional potential upside rewards, as compared to a short put. These examples help illustrate why a variety of approaches can be considered - it all depends on what is expected, and the risk profile of the trader.
A natural question to ask at this point is which of the two strategies has performed better over time?
On the aforementioned episode of Market Measures, the hosts walk viewers through tastylive research focusing on the historical performance of long stock vs. short puts in SPY from 2005 to present. The results of this study can help traders better understand how each respective strategy has performed over that period and may help you deploy positions going forward that best fit your outlook.
It should be noted that the research conducted for this comparison was only in SPY - meaning that it may not be applicable to other underlying symbols, and different time frames.
Due to the importance and complexity of this topic, we hope you'll take the time to review the complete episode of Market Measures focusing on short puts vs. long stock when your schedule allows. On the show, you’ll find the answer to the question regarding which approach performed better, as well some other helpful analytics.
If you have any outstanding questions on this topic, we hope you’ll leave a message in the space below, or reach out directly at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer. Options, futures, and futures options are not suitable for all investors. Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.
tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.
tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.
tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.