Benefits of Trading Long Put Option Position
We continue from our previous article on Long Put Option: How to Trade Long Put? Payoff Charts Explained and Maximum Profit & Maximum Loss from Long Put Option
A Long Put Option Position is said to be a protective position. The reason is that it offers a profit from sudden downwards fall in the underlying stock prices.
Say for example, you bought Microsoft stock at $30 per share (the actual underlying stock, not the option). Now, as long as Microsoft stock remains above your buy price of $30, you'll be happy, as you will be in profit.
However, if the price of microsoft stock goes below $30, say to $25, then you will be worried, because you are now in a loss.
Hence, to prevent loss making situation, you can buy what is called a protective put option - i.e. go Long on a Put Option position.
See the following Payoff Function of Protective Put Position:
The PINK graph is for Put position while RED one if for shares position.
Below $30, the slanting graphs of Put and Shares will cancel each other and hence you will not have any losses (theoretically).
Suppose you buy the Microsoft put with $30 as strike price, along with your microsoft stock purchase mentioned above. Then, how will this combination work?
There will be no effect if the Microsoft stock remains above $40. You shares postion will give you $10 as profit, and your Long Put position will be worth nothing. So your theoretical net profit will be $10.
But if the Microsoft stock price falls below $30, to say $20, then you will make a $10 loss on your share position. However, your Put will then become exercisable, and you will get (Strike Price - Underlying = $30 - $20 = $10) from the Long Put Position.
Hence, you are protected on the downside.

But one thing you must note is that we have not considered the price of the Long Put option. If you pay $5 to buy the put, then that amount will be a loss to you.

To Square off or to Exercise the Long Put Positon before expiry date?

If you are in profit in the Long put position, then you have two choices in case of American Options -
1) Either you exercise it prior to the expiry date
2) You square off (sell) it prior to expiry date

Which option should you choose?
The answer is no. 2. When a LONG option position is in profit, you must always SELL it or SQUARE it off, since you will get more money than exercising it. The reason is the Options Time Decay (see Options Time Decay: Time Decay in Options Explained with Example) When you exercise a Long option position (call or put), you only get the payoff with respect to that days underlying closing price. But when you sell it off, you also get the benefit of Time value of the option, hence your payoff is higher.
However, you must check with your optiopm broker about the brokerage charges for exercising and trading options. Sometimes, brokers have less charges for exercising options and more charges for trading (buying and selling) options