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.
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 sold||Current Market Price (Rs.)||12000|
|Put option shorted||Strike Price (Rs)||11900|
|Break Even Point (Rs.) (Sale price of Stock + Put Premium)||12100|
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