What is a covered put and how does it work?
Covered Put Summary
Selling a put against each 100 short shares enables investors to generate potential income on their short stock holdings.
A put option seller must buy the stock at the option's strike price, which will cover the short shares if the long holder exercises early or if it expires in the money (ITM) by $0.01 or more at expiration.
A put sold at a strike above the short stock trade price could result in locked-in losses if the investor is put long shares by assignment.
Although an investor can generate potential interim income by selling a short put against a short stock position, an investor still faces unlimited risk on the short shares.
Covered Put
Profit & Loss Diagram of a Covered Put
Covered Puts vs. Sell-Writes
A sell-write is like the covered put strategy. The main difference between the two strategies is how each order is placed. A sell-write is established by shorting 100 shares (a round lot) and selling an out-of-the-money put against the shares simultaneously in a single order.
For example, if the shares were trading at $450, setting up a sell-write would involve selling to open 100 shares at the current market price and selling to open a 420 strike put for $20 against it in one order ticket. The opening sell-write order would result in $47,000 ($45,000 proceeds from short stock sale + $2,000 credit received) in short proceeds, as illustrated below.
A covered put implies selling a put against an existing round lot of short stock previously established in your portfolio. When an investor sells a put against an existing short stock position, the order ticket only comprises a short put in the order ticket instead. The risk profile of a covered put will resemble a sell-write, assuming the put sold is below the short stock sale price.
In short, covered puts and sell-writes are the same position. The difference lies in the timing of selling the put, whether when establishing the short stock position or against an existing short stock position in your portfolio.
Covered Put: What's Required?
A covered put position requires a round lot of 100 shares of short stock for every short put
100 short shares also known as a round-lot (per hundred shares)
One short put per round-lot of short stock
Example of a Covered Put
Portfolio already holds 100 short shares of XYZ @ $55, which is the basis for the short sale. The current price of XYZ is $50.
Sell to Open -1 XYZ $45-strike put for $2.00 credit ($200 total credit received)
| Covered Put | Sell - Write |
Time Decay Effect | Works for the seller as time can decay the value of the put sold. | Works for the seller as time can decay the value of the put sold. |
Max Profit | Short Stock + Short Put ((Short sale basis – Short put strike) x 100) + Total credit received ((55-45) x 100) + $200 = $1,200
Only the Short Put Total credit received $200 | Short Stock + Short Put ((Short sale basis + Short put strike) x 100) + Total credit received ((50-45) x 100) + $200 = $700
Only the Short Put Total credit received $200 |
Max Loss | Infinite due to short shares | Infinite due to short shares |
Breakeven Price | Short stock sale basis + Credit received 55 + 2 = $57 | Short stock sale basis + Credit received 50 + 2 = $52 |
Buying Power Requirement | No additional buying power required when selling a short put against an existing short share position. | 100 short shares, less premium received from selling the put. |
Account Type Required |
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* Holding or establishing a short stock position requires a tasty US Options and Futures margin account.