Short Put Option Strategy

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.

  • When to Use:Investor is bullish about the stock / index.
  • Risk: Put Strike Price – Put Premium.
  • Reward: Limited to the amount of Premium received.
  • Breakeven: Put Strike Price – Put Premium
  • Profit when: The underlying security closes above the strike price.
  • Loss when: The underlying security closes below the strike price.

Let’s understand with an example:

Short Put Option Strategy

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 OptionStrike Price (Rs.)12000
ReceivingPremium (Rs.)150
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.

Conclusion

  • When you short a put option, you do so believing that the underlying security's price will rise.
  • A long put strategy offers limited profit (premium) and unlimited risk.
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