Participate in an Decreasing SPX Level with Limited Upside Risk
Please note: Commission, dividends, margins, taxes and other transaction charges have not been included in the following examples. However, these costs can have a significant effect on expected returns and should be considered. Because of the importance of tax considerations to all options transactions, the investor considering options should consult with his/her tax advisor as to how taxes affect the outcome of contemplated options transactions.
Say the SPX index is currently 1400. An investor could purchase one three-month SPX 1390 put, which represents the right to sell the SPX index at a level of 1390, for a quoted price of $25. The total cost for the put would be: $25 x $100 contract multiplier = $2,500. By purchasing the SPX put the investor is saying that by expiration he anticipates SPX index to have declined below the break-even point: $1390 strike price – $25 (the option premium paid), or an SPX level of 1365.
The investor’s profit potential can be significant as the level of the SPX index continues to decline below 1365, and is theoretically limited only because an index can decline to no less than zero. The risk for the put purchase is limited entirely to the total premium paid for the contract, or $2,500, no matter how high the level of SPX might increase.
Before expiration, if the put purchase becomes profitable the investor is free to sell the option in the marketplace to realize this gain. On the other hand, if the investor’s bearish outlook proves incorrect and SPX increases, the put might be sold to realize a loss less than the maximum.
Buy 1 SPX 1390 Put at $25
Consider three possible scenarios at expiration:
- SPX exercise settlement value below the break-even point
- SPX exercise settlement value between the strike price and the break-even point
- SPX exercise settlement value above the strike price