Not sure what’s throwing me off here. I’m obviously mistaken, but I thought the break even for a long put was the strike price - premium.
Is it the fact that the customer simultaneously purchased 100 shares of ABC stock? How should I be looking at this?
Thank you
Hi @Matthew! Good question.
The breakeven for a long put is strike price - premium, but be careful! This is the formula if an investor buys a put, and nothing else. This circumstance is different because the investor is long a put AND long stock simultaneously. When an option is no longer a “single leg strategy” (meaning it’s only the option with nothing else), you can no longer use the option formulas you learned in the long call / short call / long put / short put chapters.
This is a type of hedging strategy, which exists when an investor goes long an option with a stock position. There are two types of hedging strategies:
The options protect the stock position in both circumstances. If the long stock position declines in value, the investor exercises the put and sells the stock at the fixed strike price. Or, if the short stock position rises in value (resulting in a loss), the investor exercises the call and buys back the stock at the fixed strike price.
In this question, the investor is long 100 shares of ABC stock at $35, plus long an ABC Jan 35 put at $3. The only purpose of the put is to protect the stock position should it fall below $35 per share. Breakeven will occur when the investor makes enough money on their stock position to pay for the option premium. At $38, the long stock position has increased in value by $3 per share, which offsets the cost of the put contract (also $3 per share).
Of course, you would’ve been right if the investor only bought the put and was not long shares.
Be sure to read up on our hedging strategies chapter to learn more. I hope this helps!
Thank you, it helps. Having it click is key though, thanks for the link as well.
