Covered Put

Covered Put is created when a trader feels that the stock price is going to remain range bound. It is the opposite of the moderately bullish covered call strategy. In order to create a covered put, you have to short a stock and short a stock and also short put options on the stock.

The put sold is generally at the money or slightly out of the money. The investor is moderately bearish on a stock and shorts it but will buy it back once it reaches a target price (the strike price he shorted the put option at). The trader who wrote the put option, is subjected to a very high risk if there is a dramatic rise in the stock price. As the stock price has no limit, the risk here is very high.

  • When to Use:If the investor is of the view that the markets are moderately bearish.
  • Risk: Unlimited if the price of the stock rises substantially.
  • Reward: Maximum is (Sale Price of the Stock – Strike Price) + Put Premium.
  • Breakeven: Sale Price of Stock + Put Premium.
  • Profit when: Premium Received - Commissions Paid.
  • Loss when: Price of Underlying - Sale Price of Underlying - Premium Received + Commissions Paid.
Covered Put

In the above figure, we have underlying price on the ‘X’ or the horizontal axis and Payoff/profit on the ‘Y’ or the vertical axis.

Stock soldCurrent Market Price (Rs.)12000
Put option shortedStrike Price (Rs)11900
ReceivedPremium100
Break Even Point (Rs.) (Sale price of Stock + Put Premium)12100

Conclusion

  • You create a covered put when you are moderately bearish on a security.
  • A covered put strategy includes shorting stock and also shorting put options on that stock.
  • It offers unlimited risk and limited profit.
  • The break-even point for this strategy is Sale Price of Stock + Put Premium
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