Buying OEX Puts In Anticipation of a Market Decline

 

Who Should Consider Buying OEX Puts?


  • An investor who is very bearish on the Standard & Poor's 100 Index and wants to profit from a decline in its level
  • An investor who wants diversify a portfolio with downside exposure of the S&P 100, but may not be willing (or able) to commit the large amount of cash (margin) required for a short position in shares of multiple component issues (or the unlimited upside risk)
  • An investor who would like to take advantage of the leverage that options can provide, and with a limited dollar risk

Buying an OEX put is one of the simplest and most popular bearish strategies used by investors employing OEX index options. It allows an investor the opportunity to profit from a downward move in the level of the OEX, while committing less capital compared to the potentially significant margin requirements needed for a short sale of numerous component issues. In addition, a long put holder is not subject to either the unlimited upside risk or margin calls with increasing OEX levels as an investor with short stock positions would be.



Definition

Buying an OEX index put gives the owner the right, but not the obligation, to sell the value of the underlying index at the stated exercise (strike) price upon exercise. If the contract is exercised, the put owner will receive its cash settlement amount: the difference between the put’s strike price and the OEX exercise settlement value, times the $100 contract multiplier. Although American-style OEX index options may generally be exercised at any time prior to the expiration date. Any long OEX option (call or put) may be sold in the marketplace on or before its last trading day if it has market value.

This is a bearish strategy because the value of the put tends to increase as the level of the OEX index declines, and this gain in option value will increasingly reflect a decline in the level of the OEX when its level moves below the option's strike price.

The profit potential for a long OEX put is significant as the level of the OEX index continues to decline, and is limited only by a potential decrease in that level to no less than zero. The financial risk is limited to the total premium paid for the option, no matter how high the OEX increases. Many investors find this limited risk more attractive than the unlimited upside risk incurred from a short sale of component stocks. In addition, a short seller of shares must pay any dividends distributed to shareholders while the short position is held; a put holder does not. The break-even point is an OEX index level equal to the put’s strike price minus the premium paid for the contract. As with any long option, an increase in volatility has a positive financial effect on the long OEX put strategy while decreasing volatility has a negative effect. Time decay has a negative effect.

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