Fundamentals
Covered Put
A covered put involves selling a put option while simultaneously holding a short position in the underlying stock. Investors may use a covered put when they expect the stock price to decline moderately or remain below the put strike price through expiration. Covered puts are commonly used by investors attempting to generate income from option premiums while benefiting from downward stock price movement.
- Outlook: Bearish
- Use: Primarily used when expecting the stock price to decline moderately or remain below the strike price while generating income from selling put options
- Profit: You may profit if the stock price declines and remains at or below the put strike price through expiration
- Loss: You’ll incur losses if the stock price rises significantly because losses on the short stock position can continue increasing
Risks
Covered puts generate income through the premium received from selling the put option, but they also carry substantial risk if the stock price rises sharply. Because the strategy includes a short stock position, losses can theoretically be unlimited.
Basic example
Let’s say that you believe FlyFit’s stock price will decline over the coming months. FlyFit is trading at $100, so you short 100 shares and sell one put option with a $95 strike price for a $4 premium.
- Strike price: $95 PutStrike price represents the price at which you may be obligated to purchase 100 shares if assigned on the short put option
- Contract price: $4 ShortPer-share price of the put option contract
- Total sale proceeds: $400Options have a contract multiplier, or the number of shares represented. Total sale proceeds equal the premium received multiplied by the contract multiplier. There may be additional fees charged by your Brokerage.
If assigned on the short put option, you would purchase 100 shares for $95 per share.
Maximum profit and loss
The P/L calculations take into consideration both the short stock position and the short put option.
- Max profit: $900Short stock sale price - put strike price + premium received
- Breakeven: $104Short stock sale price + premium received
- Max loss: UnlimitedLosses can continue increasing if the stock price rises significantly.
The maximum profit occurs if FlyFit’s stock price closes at or below the put strike price at expiration.
Profit if...
FlyFit’s stock price declines below the put strike price.
- Total profit: ($100 - $95 + $4) x 100 = $900Difference between the short stock sale price and put strike price, plus the premium received
In the scenario above, FlyFit’s stock price falls below $95 at expiration. The short stock position gains value while the premium received from selling the put adds to the overall return.
Loss if...
FlyFit’s stock price rises above the breakeven price.
- Total loss: ($100 - $110 + $4) x 100 = -$600Difference between the short stock sale price and current stock price, plus the premium received
In the scenario above, FlyFit’s stock price rises to $110 at expiration. While the premium received offsets part of the loss, the short stock position still results in a net loss. If FlyFit’s stock price continues rising significantly, losses can continue increasing without limit.
Brokerage services for US-listed securities and options offered through Public Investing, member FINRA & SIPC. Supporting documentation upon request.
The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.
Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.
Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).
Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.
The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.
Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.
Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).
Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.
Options resource center
Options Foundations
Fundamentals
Chapter 9Long call
Chapter 10Long putChapter 11Protective put
Chapter 12Covered call
Chapter 13Cash-secured putChapter 14Covered putMulti-leg Strategies