A Short Put Options, also known as Naked Put option strategy, involves the sale of a put option. Selling option is also known as “writing” an option.
Outlook: With a short put, your outlook is bullish or neutral.
You are not expecting the underlying stock price to drop or the volatility to increase significantly.
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Risk and Reward
Advantages and Disadvantages
Exiting the Trade
Short Put Options Example
Assumption: XYZ is trading at $118.50 a share on Mar 20X1. You are expecting share price of XYZ to rise or move sideway. In this case, you may consider to sell one Apr 20X1 $115 strike put at $2.20 to profit from the bullish or neutral outlook of the stock. Note: commissions are NOT taken into account in the calculation.
Analysis of Short Put Options Example
Maximum Risk = Unlimited
Maximum Reward = $220 (premium collected).
Breakeven = Strike price - premium collected = $115 - $2.20 = $112.80
Selling a put is one of the simple, short term option trading strategies. Selling an option does not require you to be precise on the direction, timing or magnitude of the move and you enjoy the benefit of time decay. An option writer can also structure the short put in a way to enjoy a higher statistically probability of success than buying the stock or buying a put option.
When you short put options, it usually increases in value due to the drop in the underlying stock price or increase in volatility. It decreases in value due to time decay, a rise in underlying stock price or contraction in volatility. Therefore, to get the maximum return from trading short put options, try to ensure that the underlying stock is in an upward trend or at least range bound and also identify a clear area of support. The maximum gain is realized when the underlying stock is at or above the strike price at expiration date.
Option is a wasting asset and time decay (in your favor) accelerates exponentially in the last month before expiration. To get better trades than buying the stock itself, do ensure that you give yourself as little time as possible to be wrong. Generally this means that you should only short options that expire in less than 1 month.
One important point to take note is that if you short a put and is
assigned, you will be forced to buy the underlying stock at the strike
However, some traders considers this as an advantage as they will be able to own the stock they wish to hold at a price they are willing to pay.
The premium collected can also lower the cost basis of buying a share.
In order not to buy a stock that is falling, select the strike price around an area of strong support.
Although this strategy is one of the simple stock option strategies to execute, shorting a put options (without any risk management features) is a risky strategy as you are exposed to unlimited losses if the stock price drop. A single loss from this strategy can wipe out a few years of profit from shorting option. Most of the brokers will only allow experience traders to trade this strategy.
You should pick the
strike price and time frame of the put options according to your risk
profile and forecast. Selecting the best strike price at the appropriate
time frame is a balancing act between collecting as much premium as
possible while keeping the risk exposed to the minimum.
Bull Put Spread