The short put options strategy consists of selling a put option to receive a premium, with an obligation to purchase the underlying asset at the strike price if the option is assigned, usually when anticipating the price of the asset will remain higher than the strike price.
Traders who expect a stock or index to rise or stay range-bound are best suited for a short-put options strategy. The trader sells a put option and receives a premium with no requirement to purchase the asset at the strike price unless the option is exercised.
How It Works
When the seller sells a put option, they are paid a premium in advance, and this is also the maximum potential profit. When the price of the asset remains above the strike price until expiration, the option will expire worthless, and the seller gets to keep the premium. But when the price drops below the strike price, the seller may end up buying the asset at a loss.
Key Metrics
- Risk: Strike Price – Premium (total loss if the asset falls to zero)
- Reward: Limited to the premium received
- Breakeven: Strike Price – Premium
Example
If an investor writes a put option with a ₹4,100 strike price for a ₹170 premium when the index is ₹4,191, they retain ₹170 if the index is above ₹4,100. Losses begin below ₹3,930.
When to Use
- When the market is expected to rise or remain stable.
- For deriving short-term earnings in neutral or bullish environments.
Potential Outcomes
- Profit: The trader profits if the stock price stays above the strike price until expiration, allowing them to retain the premium.
- Loss: If the strike price is higher than the stock price, the option buyer may exercise their option, forcing the seller to buy the shares at a price higher-than-market value. Substantial losses are possible if the stock price declines significantly
Conclusion
A short-put strategy is capable of deriving consistent income during stable or rising markets. Losses may, however, become huge when prices decline. Proper market analysis, choice of strike price, and effective risk control are essential to successfully execute the short-put strategy.
