Short Put Option Explained

A short put option is a popular strategy with option income traders which allows them to potentially purchase shares of a company at a discount.

Short puts are a bullish strategy but less bullish than buying stock outright.

Selling puts allows the trader to collect a premium while waiting to potentially buy the stock at a lower price.

If you are looking to get into trading the short put option strategy, you’ve come to the right place because this article will walk you through everything you need to know.

What Is A Short Put?

A short put option is a strategy that involves the trader selling or “writing” a put option in exchange for receiving the option premium.

For receiving the premium, the put seller has an obligation to purchase the shares at the strike price if called upon to do so.

The maximum profit on the trade is limited to the premium received which is why the strategy is less bullish than outright stock ownership (stock buyers have unlimited upside).

Losses on the downside are limited, but are similar to stock ownership.

If the stock price goes to $0, then the put seller will lose the strike price x 100 less the premium received.

Let’s work through a quick example using Coca Cola (KO) stock:

Trade Date: February 5th, 2021

Underlying Price: 49.75

Trade Details: 

Sell 1 KO May 21st 47.50 put @1.70

Net Credit: $170

Capital at Risk: $4,580

short put

Here we can see that the maximum profit is equal to the premium received of $170.

The breakeven price is equal to the strike price (47.50) less the premium received (1.70) which equals 45.80.

If we multiply the 45.80 by 100 we have the capital at risk ($4,580) which is also the maximum possible loss.

In terms of the return profile, we take the premium ($170) divided by the capital at risk (4,580) which gives us a potential return of 3.71% in just over 3 months.

We can convert that to an annualized return by taking the days in a year (365) divided by the days in the trade (106) and multiply that by the return (3.71%).

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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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