Selling a Put option is opposite of buying a Put option. What you exactly sold here is the right (but not the obligation) to sell you the stock at the decided strike price.
If the price of the stock increases beyond the strike price, the short put position will make a profit for the option writer by the amount of the premium, as the buyer will not exercise the option. The amount of the premium received is the maximum profit potential. And, if the stock price decreases below the strike price, by more than the amount of the premium, the Put writer will lose money. The risk is very high.
Short Put payoff chart: 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.
|Current Nifty index||12100|
|Put Option||Strike Price (Rs.)||12000|
|Break Even Point(Rs.) (Strike Price - Premium)||11750|
This strategy limits the profits to the amount of premium I received (Rs.150). But the risk is very high in case of fall in NIFTY.
Analysis: Selling Puts can be profitable in range bound markets. Still, the writer should be careful as the potential losses can be significant, if security price falls. This strategy is often considered as an income generating strategy.
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