Short Put Explained

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Short Put

What is a Short Put

A short put refers to when a trader opens an options trade by selling or writing a put option. The trader who buys the put option is long that option, and the trader who wrote that option is short. The writer (short) of the put option receives the premium (option cost), and the profit on the trade is limited to that premium.

Basics of the Short Put

A short put is also known as an uncovered put or a naked put. If an investor writes a put option, that investor is obligated to purchase shares of the underlying stock if the put option buyer exercises the option. The short put holder could also face a substantial loss prior to the buyer exercising, or the option expiring, if the price of the underlying falls below the strike price of 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) receives a premium for 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 a premium 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.

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 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 will own 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).

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.

Short Put Example

Assume an investor is bullish on 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 simply buy shares, but this requires $3,000 in capital to buy 100 shares. Writing a put option generates income immediately, but could create a loss later on (as could buying shares).

The investor writes one put option with a strike price of $32.50, expiring in three months, for $5.50. Therefore, the maximum gain is limited to $550 ($5.50 x 100 shares). 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 needs to still buy the shares at $32.50. The loss is partially offset by the premium received.

Short Selling vs. Put Options: What’s the Difference?

Short Selling vs. Put Options: An Overview

Short selling and put options are fundamentally bearish strategies used to speculate on a potential decline in the underlying security or index. These strategies also help to hedge downside risk in a portfolio or specific stock. These two investing methods have features in common but also have differences that investors should understand.

Traders who use short selling are, in essence, selling an asset they do not hold in their portfolio. These investors do this in the belief that the underlying asset will decline in value in the future. This method also may be known as selling short, shorting, and going short.

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Traders and savvy investors using put options are also betting that the value of an asset will decline in the future and will state a price and a timeframe in which they will sell this asset.

For an experienced investor or trader, choosing between a short sale and puts to implement a bearish strategy depends on many factors including investment knowledge, risk tolerance, cash availability, and if the trade is for speculation or hedging.

Short Selling

Short selling is a bearish strategy that involves the sale of a security that is not owned by the seller but has been borrowed and then sold in the market. A trader will undertake a short sell if they believe a stock, commodity, currency, or other asset or class will take a significant move downward in the future. 

Since the long-term trend of the market is to move upward, the process of short selling is viewed as being dangerous. However, there are market conditions that experienced traders can take advantage of and turn into a profit. Most often institutional investors will use shorting as a method to hedge—reduce the risk—in their portfolio.

Short sales can be used either for speculation or as an indirect way of hedging long exposure. For example, if you have a concentrated long position in large-cap technology stocks, you could short the Nasdaq-100 ETF as a way to hedge your technology exposure.

The seller now has a short position in the security—as opposed to a long position, where the investor owns the security. If the stock declines as expected, the short seller will repurchase it at a lower price in the market and pocket the difference, which is the profit on the short sale. 

Short selling is far riskier than buying puts. With short sales, the reward is potentially limited—since the most that the stock can decline to is zero—while the risk is theoretically unlimited—because the stock’s value can climb infinitely.   Despite its risks, short selling is an appropriate strategy during broad bear markets, since stocks decline faster than they go up. Also, shorting carries slightly less risk when the security shorted is an index or ETF since the risk of runaway gains in the entire index is much lower than for an individual stock.

Short selling is also more expensive than buying puts because of the margin requirements. Margin trading uses borrowed money from the broker to finance buying an asset. Because of the risks involved, not all trading accounts are allowed to trade on margin. Your broker will require you have the funds in your account to cover your shorts. As the price of the asset shorted climbs, the broker will also increase the value of margin the trader holds.

Because of its many risks, short selling should only be used by sophisticated traders familiar with the risks of shorting and the regulations involved.

Put Options

Put options offer an alternative route of taking a bearish position on a security or index. When a trader buys a put option they are buying the right to sell the underlying asset at a price stated in the option. There is no obligation for the trader to purchase the stock, commodity, or other assets the put secures. 

The option must be exercised within the timeframe specified by the put contract. If the stock declines below the put strike price, the put value will appreciate. Conversely, if the stock stays above the strike price, the put will expire worthlessly, and the trader will not need to buy the asset.

While there are some similarities between short selling and buying put options, they do have differing risk-reward profiles that may not make them suitable for novice investors. An understanding of their risks and benefits is essential to learning about the scenarios where these two strategies can maximize profits. Put buying is much better suited for the average investor than short selling because of the limited risk.

Put options can be used either for speculation or for hedging long exposure. Puts can directly hedge risk. As an example, say you were concerned about a possible decline in the technology sector, you could buy puts on the technology stocks held in your portfolio.

Buying put options also have risks, but not as potentially harmful as shorts. With a put, the most that you can lose is the premium that you have paid for buying the option, while the potential profit is high.

Puts are particularly well suited for hedging the risk of declines in a portfolio or stock since the worst that can happen is that the put premium—the price paid for the option—is lost. This loss would come if the anticipated decline in the underlying asset price did not materialize. However, even here, the rise in the stock or portfolio may offset part or all of the put premium paid.

Also, a put buyer does not have to fund a margin account—although a put writer has to supply margin—which means that one can initiate a put position even with a limited amount of capital. However, since time is not on the side of the put buyer, the risk here is that the investor may lose all the money invested in buying puts if the trade does not work out.

Implied volatility is a significant consideration when buying options. Buying puts on extremely volatile stocks may require paying exorbitant premiums. Traders must make sure the cost of buying such protection is justified by the risk to the portfolio holding or long position.

Not Always Bearish

As noted earlier, short sales and puts are essentially bearish strategies. But, just as in mathematics the negative of a negative is a positive, short sales and puts can be used for bullish exposure as well.

For example, say you are bullish on the S&P 500. Instead of buying units of the S&P 500 exchange-traded fund (ETF) Trust (SPY), you initiate a short sale of an ETF with a bearish bias on the index, such as the inverse ProShares Short S&P 500 ETF (SH) that will move opposite to the index.

However, if you have a short position on the bearish ETF, if the S&P 500 gains 1%, your short position should gain 1% as well. Of course, specific risks are attached to short selling that would make a short position on a bearish ETF a less-than-optimal way to gain long exposure.

While puts are normally associated with price declines, you could establish a short position in a put—known as “writing” a put—if you are neutral to bullish on a stock. The most common reasons to write a put are to earn premium income and to acquire the stock at an effective price, lower than its current market price.

Here, let’s assume XYZ stock is trading at $35. You feel this price is overvalued but would be interested in acquiring it for a buck or two lower. One way to do so is to write $35 puts on the stock that expire in two months and receive $1.50 per share in premium for writing the put.

If in two months, the stock does not decline below $35, the put options expire worthlessly and the $1.50 premium represents your profit. Should the stock move below $35, it would be “assigned” to you—meaning you are obligated to buy it at $35, regardless of the current trading price for the stock. Here, your effective stock is $33.50 ($35 – $1.50). For the sake of simplicity, we have ignored trading commissions in this example that you would also pay on this strategy.

Short Sale vs. Put Options Example

To illustrate the relative advantages and drawbacks of using short sale versus puts, let’s use Tesla Motors (TSLA) as an example.

Tesla has plenty of supporters who believe the company could become the world’s most profitable maker of battery-powered automobiles. But it also had no shortage of detractors who question whether the company’s market capitalization of over US$20 billion—as of Sept. 19, 2020—was justified.

Let’s assume for the sake of argument that the trader is bearish on Tesla and expects it to decline by March 2020. Here’s how the short selling versus put buying alternatives stack up:

Sell Short on TSLA

  • Assume 100 shares sold short at $177.92
  • Margin required to be deposited (50% of total sale amount) = $8,896
  • Maximum theoretical profit—assuming TSLA falls to $0 is $177.92 x 100 = $17,792
  • Maximum theoretical loss = Unlimited

Scenario 1: Stock declines to $100 by March 2020 giving a potential $7,792 profit on the short position (177.92 – 100) x 100 = $7,792).

Scenario 2: Stock is unchanged at $177.92 by March 2020 the short expire worthlessly giving $0 profit or loss.

Scenario 3: C Stock rises to $225 by March 2020 – giving a potential $4,708 loss on short position (177.92 – 225) x 100 = negative $4,708).

Buy Put Options on TSLA

  • Assume buying one put contract—representing 100 shares—at $29 with a strike at $175 expiring March 2020.
  • Margin required to be deposited = None
  • Cost of put contract = $29 x 100 = $2,900
  • Maximum theoretical profit—assuming TSLA falls to $0 is ($175 x 100) – $2,900 = $14,600)
  • Maximum possible loss is the cost of the put contract $2,900

Scenario 1: Stock declines to $100 by March 2020 giving a $4,600 potential profit on the put position (175 – 100 = 75) x 100 = $7,500 – $2,900 contract = $4,600

Scenario 2: Stock is unchanged at $177.92 by March 2020 giving a $2,900 loss of the contract price.

Scenario 3: Stock rises to $225 by March 2020 giving a $2,900 potential loss on the put position as the put would not be picked up by another trader.

With the short sale, the maximum possible profit of $17,792 would occur if the stock plummeted to zero. On the other hand, the maximum loss is potentially infinite. The trader could have a loss of $12,208 at a stock price of $300, $22,208 if the stock rises to $400, and $32,208 at a price of $500, and so on.

With the put option, the maximum possible profit is $14,600, while the maximum loss is restricted to the price paid for the puts.

Note that the above example does not consider the cost of borrowing the stock to short it, as well as the interest payable on the margin account, both of which can be significant expenses. With the put option, there is an up-front cost to purchase the puts, but no other ongoing expenses.

Also, the put options have a finite time to expiry.   The short sale can be held open as long as possible, provided the trader can put up more margin if the stock appreciates, and assuming that the short position is not subject to “buy-in” because of the large short interest.

Short selling and using puts are separate and distinct ways to implement bearish strategies. Both have advantages and drawbacks and can be effectively used for hedging or speculation in various scenarios.

Short Put Option

B/S Strike Type Price
Sell 1 $60 Put $1.72
Net Credit ($172)

A short put is the sale of a put option. It is also referred to as a naked put.

Shorting a put option means you sell the right buy the stock. In other words you have the obligation to buy the stock at the strike price if the option is exercised by the put option buyer.

The Max Loss is unlimited in a falling market, although in practice is really limited to the total value of the exercised stock position – as a stock cannot trade below zero.

The Max Gain is limited to the premium received for selling the put option.

Characteristics

When to use: When you are bullish on market direction and bearish on market volatility.

Like the Short Call Option, selling naked puts can be a very risky strategy as your losses can be significant in a falling market.

Although selling puts carries the potential for large losses on the downside they are a great way to position yourself to buy stock when it becomes “cheap”. Selling a put option is another way of saying “I would buy this stock for [strike] price if it were to trade there by [expiration] date.”

A short put locks in the purchase price of a stock at the strike price. Plus you will keep any premium received as a result of the trade.

For example, say AAPL is trading at $98.25. You want to buy this stock buy think it could come off a bit in the next couple of weeks. You say to yourself “if AAPL sells off to $90 in two weeks I will buy.”

At the time of writing this the $90 November put option (Nov 21) is trading at $2.37. You sell the put option and receive $237 for the trade and have now locked in a purchase price of $90 if AAPL trades that low in the 10 or so days until expiration. Plus you get to keep the $237 no matter what.

The risk here is that the stock tanks before the expiration date leaving you with the potential to be exercised and take delivery of the stock at $90 when it, say, is trading at $80 when you are assigned the stock.

If the drop occurs early, and it is significant i.e. at or below the strike, you would want to re-evluate your trade and potentially exit the option position before the losses increase. If the drop in stock value occurs close to the expiration date and is not yet through the strike price, a good exit plan is to put a short stop order on the stock itself. That way you’ll be covered on the exercise if it happens while leaving the option position open to capture the remaining time value.

Short Put Greeks

Delta

Gamma

Theta

  • Bullish Spreads
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  • Short Put
  • Long Synthetic
  • Call Backspread
  • Call Bull Spread
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  • Covered Call
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  • Short Put Butterfly

Show/Hide Comments (56)

PeterMarch 23rd, 2020 at 6:26am

SkMarch 22nd, 2020 at 6:11am

Say you bought Apollo Options contract at Strike 2500 Premium 150
Draw a Short Put Pay off at below prices

PeterFebruary 22nd, 2020 at 10:46pm

No problem, happy to help! Let me know if there’s anything else.

pkFebruary 22nd, 2020 at 9:44pm

Thank you. I think I understand now. So there is no actual interest fees the trader is paying for that margin being issued from the broker for selling non-cash secured puts. But there will be hold placed on a part of your account funds while the sold put is in play, thus not being free for other trades.

Not being charged a interest fee on the non-cash secured margin amount while selling puts seems like a pretty good deal to me.

I appreciate you being patient with some of us newer traders as we try to understand the game.

PeterFebruary 22nd, 2020 at 9:15pm

I see – I think there is some confusion in terms here. What you’re referring to is a “margin” account, where the broker “lends” you some portion of money to trade securities.

However, for retails traders the margined (borrowed) value would typically only apply to stocks i.e. you couldn’t trade options on the margin value – only cash can be used. I could be wrong, but seeing as options and futures are already leveraged instruments it would be too risk for brokers to allow these to be traded on borrowed money.

The margin I am referring to is the “initial margin” – or the amount of money allocated in order to support the position.

I.e. for a short option contract, you’ve not actually bought or sold the stock; only a promise to deliver if exercised. Therefore, the broker needs to allocate some of your account to reflect the risk involved in this position. This amount is also called a margin.

Take a look at the order confirmation pad of this short put option order I placed on BBY stock;

[Click to Enlarge]

I am selling a $33.50 put option, so expecting to go long the stock at a buy price of $33.50 for 100 shares if exercised. The total exposure would therefore be $3,350, however, the broker only allocates $402 of my account to support this position; 12% of the obligated size.

This margin won’t “cost” you any interest; but will be deducted from the total amount of money in your account available for other positions.

Make sense? Let me know if not!

PkFebruary 20th, 2020 at 12:56am

I guess I might have misunderstood the concept of margin account totally?

I thought that margin account works this way:
say I have 50k in cash and based on that money they give a margin amount of 20k (I don’t know the % numbers they use to come up with margin). so now I can use up to 50k freely as it is cash backed, but the extra 20k I can use but I pay interest on it to the broker. I was using roughly 6% interest rate I would have to pay them.
So going back to my example in the previous question, if I sold puts and stayed within that amount of 50k then I don’t pay interest. But if I sold more number of puts and had to use 50k plus the 20k to cover my sold puts, I would be paying interest on the 20k to the broker? so there comes my question if selling a vertical put spread decreases the margin required from my account and thus me having to pay less interest but not maximizing my intake by not only selling puts but also buying puts in the vertical put spread VS. only selling naked puts and using up all my margin (50k + 20k) and paying some interest to the broker for the 20k?

if I did the selling of vertical put spread, I would buy an deep OTM put which is cheap just for the purposes of decreasing the margin needed.

I hope I explained it, I know it’s kinda long. what i’m trying to get to know is if saving that interest payment on the margin I don’t have to borrow anymore by doing the vertical put spread worth more vs. maximizing the full intake of selling naked puts without decreasing intake with the buying part of the vertical put spread?

Thank you very much!

PeterFebruary 19th, 2020 at 10:32pm

Yep, I hear you on the lower margin to free up capital – but not sure on the interest side of things.

I was under the impression that money allocated for margin doesn’t impact interest earned on your balance? I.e. you will still earn interest on the money whether it is taken up in margin or just sitting there. Maybe I’m mistaken – may need to clarify with my broker.

Also, going for a put spread instead of naked put depends on your view of the stock. If you’re punting on an upward movement and at the same time selling high vol options, then some downside protection is a good idea.

However, you might also be keen to go long the stock at the strike level – if it reaches that price by the expiration date – and at the same time collecting some premium in doing so.

pkFebruary 19th, 2020 at 8:28pm

I tried posting several hours ago, but my question has not showed up yet so please excuse me if this ends up being a repeat post.

Is it better to sell vertical put spreads instead of selling naked puts? What I mean is say have stock ABC at 100, selling 95 strike puts x 10 for $1/per and buying 85 strike put x10 for roughly $0.25/per instead of just selling naked put 95 x10 for $1/per?

I am asking because this will reduce the margin needed. Which would decrease the amount of interest I would have to pay on the extra margin used, roughly 6%. Plus it would free up margin that I could use for another trade. Does the extra $0.25/contract I would not lose by doing a naked put vs a vertical put, more than worth worrying about paying margin interest.

I would like to hear your thoughts?

PkFebruary 19th, 2020 at 1:22pm

Thanks for your response.

Quick question, what is your thoughts on a vertical put spread instead of just selling puts? If ABC is currently at $98, selling 95 10 puts ABC for $1 and buying 85 or 80 strike 10 puts for $0.25-$0.20; expiration date roughly 1 month out.
I know this reduces your net intake but doesn’t it also reduce the margin needed? Thus freeing up margin for use in other trades and also reducing interest on the margin? Or do you think the money saved on interest on the margin is not usually equal to the amount needed to buy the put? Given margin interest around 4-5%?

PeterFebruary 17th, 2020 at 4:02am

The problem is that as the stock crosses the strike level there is no guarantee that it will still be under the strike at expiration – and hence in need to be exercised.

What I meant to get across is that the short put option still has time value left in it i.e. a chance that it will expire out of the money and you keep the premium.

If you short the stock (by putting in a sell stop order) before the option expires, you could be left holding that position if the market rallies without taking delivery of the stock to offset it.

Sure, you can go and buy back the stock, but by that time you will surely be making a loss.

Unless I’ve misunderstood. I would also love to know a better way to play short puts ;-)

PkFebruary 16th, 2020 at 8:16pm

I just came across this article today, don’t know if you still get messages from it.

I’m kinda new to options and trying to learn.

In your last response to Francois, you said that the risk is that if the stock rallies, you are left with only the short position.
But what if we did the final part in Francois’s suggestion and placed a stop order to sell if the stock recovers above 89?

FrancoisApril 28th, 2020 at 7:02am

Nice, I like your thoughts on this, thanks for posting!

I think one problem is that you aren’t guaranteed to be assigned long stock by selling the $90 put, but if the stock does go to $89 and you have a short stop order – that you will be filled on. So, if the stock does drop to $89 then you have upside risk; you’re short the put sure, but if the market rallies prior to expiration you will only have a short stock position.

FrancoisApril 26th, 2020 at 10:25am

Protecting ‘naked’ positions when the market moves against you.

Why not simply add a stock position (place stop order at same time you enter naked put or call) to your naked positions when they get ITM?

IE: XYZ trading at $100
– SELL 90PUT for $2 (break-even is now $88, max profit $2, max loss $88)
– Place stop order to SHORT stock at, say, $89
– IF stock goes down below $89 then you are entered SHORT on XYZ @ $89 so that you then get to keep $1 of your premium sold AND you are fully protected as the stock continues to decline
– From there you can place stop order to sell stock if price recovers above $89, etc.

If at expiry XYZ declined to $80:
– you have the $2 premium on the 90PUT sold
– you get assigned the stock at $90 (pay $90 minus $2 credit received but it’s worth $80 so loss of $8)
– you cover your short position (sold for $89, buy back at $80 = profit of $9)
– overall profit of $1

Same goes for selling naked calls; place stop order slightly ITM to enter LONG stock and you get to keep some of your premium sold AND fully protected as stock climbs further.

Adds slightly to cost of maintenance (commission, spread) but is definitely much cheaper than buying pack a deflated option.

Am I missing something here??

PeterMarch 5th, 2020 at 5:51am

Well, I suppose that is the strategy ;-) short the put, wait for it to decline until you reach your profit target.

NewbzMarch 1st, 2020 at 7:10pm

Peter, yeah it would be a loss if I bought a short I sold at a higher price — that makes sense.

Well, are there any strategies that involve writing a short contract for $1, hoping it goes down to 50cents then buying it back so you end up with a Net Gain of 50cents instead of the $1 premium?

Ideally, you want the option to expire, but maybe in the case of a naked call/put you’d buyback if you’re worried about the buyer going through with the contract.

PeterMarch 1st, 2020 at 6:38pm

Hi Newbz, if you sell short a put at $1 and then buy the same put for $2 then you make a loss of $1. Just like you would if you bought it first for $2 and sold it out for $1.

But yes, the participant who holds the short position is the one who is ab ligated to deliver if assigned.

It might not necessarily be the same person who was on the other side of your transaction. The options clearing house aggregates all of the option positions based off the trading through a process called novation (see the section titled “Application in financial markets”).

NewbzMarch 1st, 2020 at 4:56pm

Peter, it turns out there weren’t any buyers for that option I was selling — problem solved.

I have another question, and I asked a similar one to this in the Long Call entry on this site.

If I write a Short Put for $1 and lets say the value of that contract increases to $2 and now I want turn a profit. Is the person who buys the short put contract from me now obligated to fulfill the contract instead of me?

PeterMarch 1st, 2020 at 4:48pm

Hi Newbz, what is the simulator you are using?

I’m not sure how it all works with a simulator i.e. why there aren’t any buyers or where the bids are supposed to come from. but if the option has some intrinsic value there will always be a buyer as market makers will bid basis getting a hedge in the underlying.

However, if the option is out-of-the-money and very close to expiration then it is possible that there won’t be any buyers and you will just have to allow the option to expire worthless.

NewbzMarch 1st, 2020 at 10:59am

I’m using a stock simulator for short putting and I’m trying to sell 10 contracts of a 50cent strike price. The bid is 0 and the ask is 20cents.

Obviously selling it at 0 is pointless, so I tried 10cents and waited a bit. the order remained open. Moved it to 5cents and waited. still an open order.

I don’t care about getting a sell price closer to the ask, but I don’t want to settle on a bid of 0 either. This simulator only lets me increase the price in increments of 5cents, so I can’t set my price to 1cent either.

This is only paper trading so it’s not a big deal, but what happens if I encounter this problem during real trading. The contract will never get sold because it’s not at bid price, which is 0 so why would I sell it.

PeterNovember 16th, 2020 at 7:46pm

Mmm..yeah, not too sure. I could guess and say that the $178 is the loss between the sold price and the current market price, however, you say 0.27 is the current price? Unless the position is valued against a price other than 0.27 – say average of the bid/ask spread or last, which may be some other price.

Then I would have said that the $280 was the loss including commissions. But that would suggest that you pay approximately $10 per contract in brokerage. What are your rates?

By the time the option expires, if it is still out-of-the-money, then the price of the option will have traded from 0.27 to zero so the unrealized losses will have been credited back into your account and you will be left with the $110 credit from the initial sale (minus brokerage fees).

MarkNovember 16th, 2020 at 6:11pm

Sorry I guess I should have mentioned that I purchased 10 option contracts

MarkNovember 16th, 2020 at 6:06pm

Thanks for the quick reply Peter. I am using Etrade as the broker. I do see the margin of 4400 or so where there are accounting for what you are talking about.I am hoping that it doesnt have to get excerised and my concern is why the show of a loos. when I looked at the position in my main account it does show a market value loss of -$280 however in my trader platform it shows a loss of -$178. The strike price for the option I bought is 119 which expires in a few days. Assuming we never get that low by the end of the week, say maybe 121, which would still showing a loss. What happens to the loss? Do i still get the premium?

PeterNovember 16th, 2020 at 5:23pm

When you initially sold the put, $11 would have been credited to your account. But your position will be revalued according to the current market prices, so with the option now at 0.27 you would have a $16 loss on the position.

However, because you are short a naked option your broker will also deduct some money from your account as a margin in case you are exercised and have to take delivery of the underlying position. In this case, as it is an index, there won’t be an exercise so the margin is used as a buffer against a large loss.

Is there a way that you can see the transaction breakdown to confirm? What broker do you use?

MarkNovember 16th, 2020 at 4:06pm

I sold a naked put today. (sell to open a put OTM for SPY) It was the 119 nov put and i sold it for .11. I just wanted the premium for it. The market went down today and that same put is now .27. It is now showing a loss in my positions of about $180. Is this normal. I am assuming i can let this expire but what about the loss, dows it expire with the option?. Is it charged to me? because I dont see a premium recieved anywhere on my site.

PeterSeptember 7th, 2020 at 7:48pm

Yes, you’re right – the $5 put vs the $5 call implies a forward price for the stock of $3.13. I’m not sure why. I thought at first that it could be because of a dividend but the company has never paid a dividend and a $2.17 per share dividend seems a bit unrealistic.

I’ve asked a friend of mine who is a market maker for Australian stock options if he has any ideas and I’ll reply when/if I find out.

SamSeptember 6th, 2020 at 1:42am

As I can see, the market is not that simple ir practice. If you take LDK solar, the put options are severly overpriced. Current stock price is $5,3, and December calls/ puts with strike price 5 are $0,7/$2,3 and the put is not even ITM.

The problem is that it is difficult to get the stock short, so you can’t really hedge fully. Anyway, a week ago it was possible to form a position of -100 stocks, +2 calls and -1 put with guaranteed profits of

18% in four months, the only problem is that you can’t really go short easily :)

And i guess you can’t be sure you will profit since the short might be recalled anytime.. Not a perfect market

PeterSeptember 5th, 2020 at 5:34pm

Hi Sam, no you are right. This would present an arbitrage opportunity. Calls and puts must be priced according to the put call parity theorem.

This states that Call – Put = Stock – Strike.

Read more about put call parity here.

SamSeptember 1st, 2020 at 6:24am

Thank you, Peter. One more thing that is on my mind:

If ATM call and put options are traded at a huge difference, might there be an arbitrage opportunity?

Lets say:
the stock is at $10
$10 call trades at $1
while 10 put trades at $5

As I understand, they should trade close to each other.. What is my mistake?

In this example, if you short the stock, long 2 calls and short the put, you will fully hedge yourself and stay long with profits from an increase in price.

here is an improvised table based on the numbers. Am I missing something?

0 5 10 15 20 stock price

10 5 0 -5 -10 short the stock
-2 -2 0 10 20 long 2 calls
-5 0 5 5 5 short 1 put

3 3 5 10 15 RESULT

Based on these prises (if you are able to find this misspricing), you get a quaranteed hedged profit with it going up if the prices go up. I AM PUZZLED, so please tell me where is my mistake :) Thank you in advance :)

PeterSeptember 1st, 2020 at 2:13am

Because you’ve sold the put your risk is that the market goes down and the buyer of the option exercises it.

If the put buyer exercises his/her option then you are obliged to buy the stock from him/her at the strike price.

So, in your case, if exercised you would have to take delivery of the stock at $10 and pay $1,000 per contract ( 10 x 100).

You would, however, keep the premium received when you initially sold the put option.

SamSeptember 1st, 2020 at 2:04am

Hi, I am a bit confused now:
let’s say I short a put with a strike price of 10. Isn’t the maximum loss I can take is -10 per share minus the premium (-1000 per contract)? In the same way as the put has a limited profit payout?

Are there any other points I need to look into? How do options react to splits, bankruptcy and so on?
I am pretty new in options trading, and sold a put with the plan to hold it until expiry, what are the risks involved?

PeterAugust 9th, 2020 at 4:06am

ha ha, it’s no problem!

1. If you need to calculate the premium of an option then you will need to first understand the mechanics of option pricing. Then you will need a calculator – you can download my option spreadsheet, which calculates an option’s fair value.

However, you’ll probably not need to calculate the option price yourself – the bids and offers in the market are what you’ll be buying and selling against anyway.

2. Yes. If the order is still in the market waiting to be filled, the trader can just remove the order before it is filled if s/he changes his/her mind.

3. Yes. There is a screen shot on this page that shows what we call an option chain.

4. Yes. But it depends on the platform that you’re trading with. I use Interactive Brokers and they have a “reverse position” button that if you click it opens up an order ticket to do the opposite of your existing position.

NatAugust 9th, 2020 at 12:37am

I just hate myself for bothering you again, but you seem to be the perfect options teacher. I have 4 questions as follows?

1. How do you calculate the premium of the option?
2. If the seller of the option realizes that he doesn’t want to sell his option although he has placed a sale order, but no one has bought it yet, can he cancel his sale?
3. When the buyer enters the trading platform (goes into the market to do his shopping), does he see a list of option contracts offered at different prices? Then he chooses to buy the one he wants that meet his specification, by placing an order?
4. When offsetting the position, do you simply place a sale or purchase order? There is no specific offset button, right?

Thank you so much and I hope that I don’t have to bother you anymore after this.

PeterAugust 8th, 2020 at 7:59pm

Correct. Although technically, you don’t actually “pay” a margin to the broker. The margin amount is “allocated” from your account by your broker in case you incur a large loss. The difference is that you should still earn interest on the margin.

NatAugust 8th, 2020 at 7:28pm

I think I understand almost everything now, thanks to your explanation. One last question is, if the seller of the put option (or call option) offsets his position, when he does that does the margin that he has placed with the broker get returned to him after he closes his position?
Thank you.

PeterAugust 8th, 2020 at 1:48am

Kind of – although the buyers and sellers at the time of the transaction are not necessarily the ones to swap obligations for delivery.

If an option buyer decides to exercise, then the clearer will choose (at random I believe) a participant who has a short option position to exercise.

This process is called novation.

NatAugust 8th, 2020 at 12:28am

Do you mean that the seller (let’s call him seller a) buys it back from any seller (in this case, let’s call him seller b) in the market? Then, seller b (the person he bought the option from) will be obliged to buy from the original buyer whom he sold his put option to in the first place instead of him? Is that how seller a closes out his position and exits any obligations that he has on him?

Thank you and sorry for taking so much of your time. You have been most helpful to me.

PeterAugust 7th, 2020 at 7:55pm

A short position is offset in the same way that a long position is – by doing the opposite trade. In this case by buying the same option contract back from a seller in the market.

NatAugust 7th, 2020 at 7:35pm

Now I am confused about how the seller of a put closes out his position. He will buy the same contract with the same strike price and expiry date to offset the one he sold. Now, who does he buy it from and how does this close out his position as the seller of the put contract and leaves him with no obligation?

Thank you once gain for your help.

PeterJuly 14th, 2020 at 10:56pm

Hi Larry, the term “naked” is used to describe an option position where you don’t have any downside/upside protection. In the case of a short put it is referred to as “naked” because your risk as the market sells off continues all the way until the market reaches zero.

LarryJuly 14th, 2020 at 9:40pm

I don’t understand what you mean by naked when you state “selling naked puts. ” in your description above. I understood that by selling a put option I might have the stock “put” to me at the strike price of the option, but I don’t see what I’m “naked” of.

PeterOctober 25th, 2020 at 7:20pm

Some solid tips there Joel. thanks!

When you say 50/200 trend zone. are these simple moving averages?

JoelOctober 25th, 2020 at 5:41pm

I agree that selling the put is a good way to buy the stock for a bit less than the current selling price – in other words, to take advantage of a dip during the option period. I’m using this to buy strong dividend paying stocks at a discount if they are above the 50/200 day trend line, and I want to own that stock anyway – as Mjasko noted about Goodyear.

So the strategy for dealing with otherwise idle and unneeded cash that is sitting besides an otherwise fully diversified portfolio:

1 – find a reliable stock you want to own that also pays a good dividend – Motley Fool Income report has many suggestions, as do other sources/articles.
2 – understand the stock’s valuation, making sure it has room to rise
3 – look at the ‘technical’ chart (e.g., on Yahoo) and see the zone between the 50-day and 200-day trend lines. If you’re basically bullish on the stock, you’ll want to buy between them, expecting a bounce at or above the 200 day line.
4 – Look at the next dividend date
5 – If the current price is within the 50/200 day zone, buy the stock and sell a covered call (Buy-Write); you’ve already got the price you want, and you can start collecting dividends and option premiums. If then option is called and you ‘lose’ the stock – although you’ve ‘missed’ additional upside, you’ve still made money – repeat all steps, including step 6 below.
6 – If the current price is above the 50/200 day zone, look for a strike price within that zone, and pick an option exercise date that has reasonable volume (you can see all of that on Yahoo Quote on the symbol, and then Options). Sell the put, pocket the cash, and see if the price drops into the 50/200 day zone and you get the stock. If it doesn’t, then do all the stpe over again – you’re only missing the upside of something you don’t own.

If somehow this is your primary investment strategy, you are probably better off doing it through a buy/write ETF or closed end mutual fund and not on your own.

Mike GriffinSeptember 23rd, 2020 at 5:08pm

Here’s how a short-put works: you sell the put (thus getting the put-price x 100). You either keep the put until expiration, or you buy the same put (at whatever the current put-price is) to “close” your position. If you close then your profit (or loss) is the difference between the sold put-price and the current put-price (put-price is another way of saying “premium”).
If it looks like the stock-price will remain above the strike-price then you should probably hold the short position until expiration, because the put will probably expire worthless and you will be able to keep the “premium” you got for selling the put in the first place.
If it looks like the stock-price will drop below the strike price at any time before expiration, (because of expected bad news, bad earnings report, etc.) then you should close your short position as soon as possible. Got it?
PS-being long a put is the opposite of being short, (i.e. you buy the put instead of selling it).

PeterAugust 11th, 2020 at 6:04pm

It is only worthless if the underlying is trading above the strike price at the expiration date.

If the underlying is trading below the strike price at the expiration of the option then the option is worth the strike price minus the underlying price, which is your loss if you are short the option.

Emmanuel ArmahAugust 11th, 2020 at 10:29am

I don’t understand why we use unlimited loss,
because you know your losses right from day one that the maximum loss is when the option expires the option becomes worthless.

MjaskoApril 16th, 2009 at 12:52pm

All of these comments deal with short term loses or gains. For me the question is whether the stock or company in question is a good buy at some price. If you believe that Goodyear is a good buy in any case at 15 and the stock is 20 who is really worried if Goodyear goes to 5 in the short term. All my equities have loss value lost value in the past year. Do I like it? No. But I am not in the market short term. Do I expect the market to go to zero. If it does then I have a lot more to worry about than the lost of a few dollars. Goodyear at zero is absurd. so why all the talk of unlimited loss. If you are so worried about loss stay out of the market. If you are long-term bullish then selling puts makes sense

AdminFebruary 15th, 2009 at 2:23am

You aren’t anticipating the stock to drop. you are anticipating it to rally. If the stock is above the strike at expiration you keep the premium.

SGL#February 15th, 2009 at 1:33am

How is a short put considered bullish if you are anticipating the stock to drop?

AdminDecember 18th, 2008 at 6:22pm

Yep, noted. I mentioned it below too:

“I guess it is not really unlimited as a stock price cannot go below 0.”

RickDecember 18th, 2008 at 1:13pm

“Maximum Loss: Unlimited in a falling market.”, not really , how far can AAPL fall , cant go beyond 0 (zero)

AdminDecember 8th, 2008 at 3:15am

Not sure what you mean. Are you saying that your broker won’t allow you to sell a put option?

MarloweNovember 27th, 2008 at 10:29am

I would like to carry out the AAPL trade for real, however I am told I can not carry naked put. But, I can buy a call which will cover me. What are the suggestions for this? Happy to own the stock.

AdminNovember 7th, 2008 at 7:10pm

I think the max loss on a short put is [(stock – strike) + premium] and seeing as the stock price is unknown and can therefore be anything it is reasonable to say unlimited.

johnOctober 31st, 2008 at 9:03am

yes i agree the max loss is [(Strike-Premium) – 0]. There can be large losses if the strike is large, but there is certainly limited downside.

AdminSeptember 23rd, 2008 at 10:27pm

A short put means that you are obligated to buy the underlying at the strike price if the buyer decides to exercise. So the payoff is the stock price minus the strike price less the premium received.

Once the underlying stock trades below the strike price price the option becomes out of the money. The option will continue to lose money as the stock continues a downward price movement.

I guess it is not really unlimited as a stock price cannot go below 0.

chrisSeptember 23rd, 2008 at 2:01pm

Isn’t the maximum loss for a short put the Strike price, not unlimited? This is not including the premium made on the sell of the put. So the net loss would be the Strike price minus premium

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