What is a covered put and how does it work?
A covered put offers protection against higher market volatility while enabling you to collect a premium and may be useful when your outlook is neutral or slightly bearish. Discover what a covered put is and how it works.
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Contact us 0800 409 6789
Call 0800 195 3100 or email newaccounts.uk@ig.com to talk about opening an account.
Contact us 0800 195 3100
Get info fast via our instant help and support portal. Available for account queries, ProRealTime, product info and more.
Visit help and support for more information.
Get info fast via our instant help and support portal. Available for account queries, ProRealTime, product info and more.
Visit help and support for more information.
Call 0800 409 6789 or email helpdesk.uk@ig.com if you have any questions about trading or investing. We’re available from 9am to 5pm (UK time), Monday to Friday.
Contact us 0800 409 6789
The content on this page relates specifically to listed options, which can be traded using our US options and futures account.
What is a covered put?
A covered put is an options trading strategy in which you short-sell shares of a stock or an exchange-traded fund (ETF) while simultaneously selling a put option on that stock or ETF. The strategy enables you to hedge against potential losses on an existing short position and generate a profit when the market sentiment is neutral or slightly bearish.
With us, you can employ a covered put using a US options and futures margin account.1
A covered put requires:
Short shares. You’d need at least one round lot (ie a quantity of 100) of these shares
One short put option per round lot of short shares. In exchange for writing the put, you’ll receive a premium, which will help cushion against a potential increase in the price of the shares you’re shorting
As mentioned above, the shares traded in this strategy could be in a stock or an ETF. However, for the sake of simplicity, we’ll focus exclusively on covered puts on stocks on this page.
The put option that you write gives the contract holder (ie the buyer) the right to sell you shares at a set price (the strike price) by a certain date (the expiry date). In exchange for this right, the buyer will pay an upfront fee. This fee is known as the premium and will be paid to you as the put writer.
What’s the difference between a selling a covered put and writing a covered put?
Selling a covered put and writing a covered put are one and the same. They mean that you’re trading a short put option while holding a short position on the underlying asset. The terms 'selling' and 'writing' are interchangeable in options trading, both indicating that you’re the counterparty to the option holder (who initiates the options contract).
When you write a covered put, you commit to buying the underlying stock at the option’s strike price if the contract is exercised by the expiry date or it expires in the money (ITM). Your short options position serves as a hedge for the short stock position. So, if the stock price rises significantly, the premium and potential profit generated from the options position could shield you against possibly extensive losses on the short stock position.
How does the covered put options strategy work?
A covered put is a neutral to slightly bearish strategy that involves holding a short position on shares of a stock and simultaneously selling a put option on that same stock.
If the put holder exercises their right to sell the underlying shares or the option expires ITM, you (as the option seller) would be obligated to buy those shares. This is called ‘assignment’.
A put option buyer can exercise their right to sell at any point in the duration of the contract. If, instead, they allow the contract to expire, it’ll be automatically exercised if it’s ITM by $0.01 or more
Once the option has been exercised, the put seller must buy the stock (due to assignment) at the contract's strike price
You must ensure that you have enough funds available to buy the underlying stock in case the option is exercised (whether manually or automatically).
Factors that can impact a covered put’s effectiveness include the put option's time to expiry as well as the stock's volatility, market depth and cost (eg certain stocks may be subject to hard-to-borrow fees, which may be charged settlement to settlement).2 Careful consideration of these variables is crucial to increasing your probability of favourable outcomes.
Covered put profits and losses
Potential profits and losses on a covered put depend on how the underlying market performs in relation to the two positions that make up the strategy.
The short share position is neutral to bearish
The short put position is neutral to bullish
Combining the two positions reflects a neutral to slightly bearish assumption, as markets consistent with that assumption would provide the optimal conditions for the covered put strategy to generate a profit. Even though the short put position leans toward the bullish side, you wouldn’t want the underlying to trade upwards, as that would likely result in a loss on the short share position.
Assignment on the short put may result in a loss if the stock price is below the strike price, but this loss could be offset by the premium received for selling the put and potential profits from the short stock position.
The maximum profit for the covered put strategy is capped and occurs when the stock price drops to, or below, the level of the strike price and the strike price is below the price at which you entered the short share position. The maximum loss for the strategy, on the other hand, is unlimited. That’s because the price of a stock can, in theory, keep rising (ie there’s no limit to the losses that could arise from the short share position).
Covered put trading example
Let’s say you hold 100 short shares of XYZ. The cost basis of this short stock position (ie how much you paid to open the position) is $55 per share. XYZ is currently trading at $50 per share.
You ‘sell to open’ a put contract on XYZ at a strike price of $45. You receive a premium of $2 per share ($200 in total, since each standard equity options contract represents 100 shares of the underlying stock).
Time decay effect |
Works for the seller, as time decay will decrease the value of the put sold |
Maximum profit |
Profit from the short stock position + profit from the short put
([Short sale basis – short put strike] x 100) + total credit received for the put |
Maximum loss |
Infinite due to the short stock position, since the underlying asset’s price can – in theory – rise in perpetuity (making it crucial that you manage your risk) |
Breakeven price (per share) |
Short stock sale basis + credit received for the put |
Account type required |
US options and futures margin account1 |
Benefits and risks of the covered put strategy
Just like all other trading activity, there are benefits and risks to using the covered put strategy.
Key benefits
Profit generation: you could make a profit from the short stock position and the short put position
Hedging: if the underlying asset’s price rises, the short put position will help offset losses on the short stock position
Downside protection: the premium received for the put reduces the breakeven point for the strategy – it acts as a buffer against minor increases in the underlying asset’s price
Flexibility: you can adjust your positions (eg by rolling the put to a later expiration date) based on market conditions
Key risks
Limited upside potential: the maximum possible profit is limited by the short put option. That’s because gains on the short stock position are no longer possible once the underlying asset’s price has fallen to the level of the put’s strike price
Unlimited downside potential: the price of a stock can, in theory, keep rising (which means that there’s no limit to the losses that could arise from the short stock position)
Margin requirements: the capital required to employ the strategy could be substantial, since you need to maintain both the short stock and the short put positions
Stock borrowing: hard-to-borrow fees can eat into potential profits2
Assignment risk: if the put is exercised or allowed to expire ITM, you’ll be obligated to buy the underlying asset, which means losing the shares associated with the short stock position
FAQs
What is a covered put?
A covered put is a trading strategy which involves selling a put option against short shares of a stock. You’d sell one put option for every 100 short shares held. In a neutral market, a covered put – through the premium received for selling the put – enables you to generate profit while maintaining the short stock position. The maximum profit from the strategy is capped, but potential losses are unlimited, so it’s crucial to manage your risk carefully.
Learn more about what a covered put is
How can I employ the covered put strategy?
To employ a covered put, you’d sell one put option for every 100 short shares held. You’d do so with the aim of hedging your short share position or of making a profit.
See a covered put trading example
Can anyone use the covered put strategy?
Yes, traders of all experience levels can use the covered put strategy, but because of the complexity and risk involved, it’s important to build a solid understanding of the strategy before trying to implement it. Doing thorough research can help you understand the relevant concepts and gain the insights needed to employ the covered put strategy.
How do time decay and implied volatility impact a covered put?
Time value in options prices works for you, as the seller, because time decay decreases the value of the put sold.
Implied volatility (IV) has several impacts on covered puts. These include:
Put premium impact: higher IV equals higher put premiums received; lower IV equals lower put premiums received (since you're short the put, high IV works in your favour for initial premium collection)
Stock borrow relationship: high IV is typically correlated with higher stock borrowing costs, which creates a tradeoff – a better premium for the put option, but higher carrying costs for the short stock position
Risk-reward profile: high IV environments often signal market uncertainty. While you could collect larger premiums, there's increased risk of sharp moves in the underlying asset’s price in either direction (upside risk is particularly concerning since you're short the stock)
Can you adjust or roll a covered put?
Yes, you can manage your covered put by making adjustments to your positions – like rolling the put to a later expiration date.
It’s important to note that changes in IV can affect your ability to roll options positions. During IV spikes, rolling puts becomes more expensive, but it could be more profitable as well.
Can you use a covered put for hedging?
Yes, you can use a covered put for hedging. With this strategy, the short options position serves as a hedge for a short stock position. When employing a covered put, you should ensure that you have sufficient funds to buy the underlying stock at the option’s strike price, which you’d need to do if you were assigned.
Try these next
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1 You can trade US-listed options in a margin or cash account. When you trade in a margin account, you’ll have more strategies available to you – eg selling naked call options and defined-risk options spreads. Options positions aren’t fully cash-secured (eg you aren’t necessarily required to put up the buying power in full upfront) in a margin account. In a cash account, options trading is non-marginable (ie you can’t borrow cash to establish positions, so you’ll commit the full value of your trade upfront).
2 We must borrow stock to enable you to take short positions as you cannot sell something you don’t have. Some stocks are considered ‘hard to borrow’ owing to lack of availability. There’s a charge associated with these stocks, namely the hard-to-borrow fee. Settlement to settlement means that the hard-to-borrow fee is charged until the shares settle, ie for every day that your position is open (including weekends). Shares and options settle on a T + 1 (transaction plus one day) basis. So, if you take a short position today and close it today, no hard-to-borrow fees apply because the whole trade will settle tomorrow. But, if you take a short position today and close it tomorrow, the opening will settle tomorrow and the closing will settle in two days.
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