Short Put
Components
A short put is simply the sale of a put option.
Risk / Reward
Maximum Loss: Unlimited in a falling market.
Maximum Gain: 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 are unlimited in a falling market.
Although selling puts carries the potential for unlimited 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.
Comments (13)
Peter
August 11th, 2010 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 Armah
August 11th, 2010 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.
am i right ?
Mjasko
April 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
Admin
February 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?
Admin
December 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."
Rick
December 18th, 2008 at 1:13pm
"Maximum Loss: Unlimited in a falling market.", not really , how far can AAPL fall , cant go beyond 0 (zero)
Admin
December 8th, 2008 at 3:15am
Hi Marlowe,
Not sure what you mean. Are you saying that your broker won't allow you to sell a put option?
Marlowe
November 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.
Admin
November 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.
john
October 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.
Admin
September 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.
chris
September 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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