A short put refers to when a trader opens an options trade by selling or writinga put option. The trader who buys the put option is longthat option, and the trader who wrote that option is short.
The writer (short) of the put option receivesthe premium(option cost), and the profit on the trade is limited to that premium.
Key Takeaways
A short put is when a trader sells or writes a put option on a security.
The idea behind the short put is to profit from an increase in the stock's price by collecting the premium associated with a sale in a short put.
Consequently, a decline in price will incur losses for the option writer.
A short put is also known as an uncovered put or a naked put. If an investor writesa put option, that investor is obligated to purchase shares of the underlying stock if the put option buyerexercises the option.
The short put holder could also face a substantialloss prior to the buyer exercising, or the option expiring, if the price of the underlying falls below the strike priceof the short put option.
Short Put Mechanics
A short put occurs if a trade is opened by selling a put. For this action, the writer (seller) receivesa premiumfor writing an option. The writer's profit on the option is limited to that premium received.
Initiating an option trade to open a position by selling a put is different than buying an option and then selling it. In the latter, the sell order is used to close a position and lock in a profit or loss. In the former, the sell (writing) is opening the put position.
If a trader initiates a short put, they likely believe the price of the underlying will stay above the strike price of the written put. If the price of the underlying stays above the strike price of the put option, the option will expire worthless and the writer gets to keep the premium. If the price of the underlying falls below the strike price, the writer faces potential losses.
Some traders use a short put to buy the underlying security. For example, assume you want to buy a stock at $25, but it currently trades at $27. Selling a put option with a strike of $25 means if the price falls below $25 you will be required to buy that stock at $25, which you wanted to do anyway. The benefit is that you received apremium for writing the option. If you received a $1 premium for writing the option, then you have effectively reduced your purchase price to $24. If the price of the underlying doesn't drop below $25, you still keep the $1 premium.
Risks of Selling Puts
The profit on a short put is limited to the premium received, but the risk can be significant. When writing a put, the writer is required to buy the underlying at the strike price. If the price of the underlying falls below the strike price, the put writer could face a significant loss.
For example, if the put strike price is $25, and the price of the underlying falls to $20, the put writer is facing a loss of $5 per share (less the premium received). They can close out the option trade (buy an option to offset the short)to realize the loss, or let the option expire which will cause the option to be exercised and the put writer willown the underlying at $25.
If the option is exercised and the writer needs to buy the shares, this will require an additional cash outlay. In this case, for every short put contract the trader will need to buy $2,500 worth of stock ($25 x 100 shares).
Short Put Example
Assume an investor isbullishon hypothetical stock XYZ Corporation, which is currently trading at $30 per share. The investor believes the stock will steadily rise to $40 over the next several months. The trader could buy shares, but this would require $3,000 in capital to buy 100 shares. Writing a put option generates income immediately, but could create a loss later on if the stock price falls (as could buying the shares).
The investor writes one put option with a strike price of $32.50, expiring in three months, at $5.50. Therefore, the maximum gain is limited to $550 ($5.50 x 100 shares), which occurs if the stock closes at $32.5 or higher at expiration. The maximum loss is $2,700, or ($32.50 - $5.50) x 100 shares. The maximum loss occurs if the underlying falls to zero and the put writer is assigned to buy the shares at $32.50. The maximum loss is partially offset by the premium received from selling the option.
Some traders use a short put to buy the underlying security. For example, assume you want to buy a stock at $25, but it currently trades at $27. Selling a put option with a strike of $25 means if the price falls below $25 you will be required to buy that stock at $25, which you wanted to do anyway.
Expiration risks associated with short puts are contingent on what happens at the contract's expiration date. The primary risk is the underlying asset's price falls significantly below the put option's strike price, obligating the seller to purchase the asset at a higher price than the current market value.
Imagine a bullish investor trading on the stock of XYZ company. Now, XYZ company is trading at Rs 500 per share but the investor who has a bullish approach and perhaps some insight into the stock believes that the share of XYZ will rise to 600 in a few months.
The advantages of using short put options include the ability to generate income and the potential to acquire a stock at a lower price, while the disadvantages include the obligation to purchase the stock at the strike price and the potential for unlimited losses if the stock price falls below the strike price.
Losses for short-sellers can be particularly heavy during a short-squeeze, which is when a heavily shorted stock unexpectedly rises in value, triggering a cascade of further price increases as more and more short-sellers are forced to buy the stock to close out their positions.
The short put is a bullish options trading strategy, so you would use it when you expect a security to go up in value. Because you can only make a fixed amount of profit, it's best used when you are expecting a security to go up in value by just a small amount.
A Short Put can be devised by selling one lot of 15500 PE (ATM) @ 200.Net Premium Paid or Received = Rs.(+200). Uncapped Loss will if market started trading below at 15500 - 200 = 15200, Max premium will be earned if underlying stays above the strike i.e., 15500.
If an investor wants to extend the trade, the short put option can be rolled out to a future expiration date. Rolling out the option requires buying-to-close (BTC) the short put and selling-to-open (STO) a new put option with the same strike price for a future date.
A short put is when a trader sells or writes a put option on a security. The idea behind the short put is to profit from an increase in the stock's price by collecting the premium associated with a sale in a short put. Consequently, a decline in price will incur losses for the option writer.
In contrast, a short put position may be covered by either selling short the underlying stock, by purchasing a put option, or by selling a call option on the stock.
Short Put. If you hold an in-the-money short put on the expiration date, the underlying is booked long into your securities account at the strike price. If the short put is out of the money or at the money, it expires worthless and no exercise takes place.
A short put will incur losses if the put closes below the breakeven zone at expiration, which is defined as the short put strike less the credit received up front for selling the put contract. Please be mindful of assignment risk for ITM short options, as assignment can happen at any time up to the expiration date.
By shorting, you could hedge exposure and create a short position. If the stock falls, you could repurchase it at a lower rate and keep the difference. Meanwhile, put options could directly hedge risk. Puts are considered suitable for hedging the risks of decline in a portfolio.
A put option allows the holder to sell an asset at a specified price before a specified date. An example would be to purchase a Rs. 100 put option on Stock X. The stock can be sold if its price falls below Rs.
If the price of the underlying falls below the strike price, the put writer could face a significant loss. For example, if the put strike price is $25, and the price of the underlying falls to $20, the put writer is facing a loss of $5 per share (less the premium received).
Covered Put: Investor A purchases a put on a stock they currently have a long position in. Potentially, they could lose the premium they paid to purchase the put if the option expires. They could also lose out on upside gains if they exercise and sell the stock.
With a short put options position, the trader accepts the obligation to buy the stock at the strike price when the market price of the stock will likely be lower and could continue to fall.
While there are some similarities between short selling and buying put options, they have different risk-reward profiles that make both unsuitable for novice investors. That said, buying puts is much better suited for the average investor than short selling because of the limited risk.
Introduction: My name is Msgr. Refugio Daniel, I am a fine, precious, encouraging, calm, glamorous, vivacious, friendly person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
:max_bytes(150000):strip_icc()/dotdash_Final_Short_Put_Apr_2020-01-c4073b5f97b14c928f377948c05563ef.jpg "Short Put: Definition, How It Works, Risks, and Example (1)")
