Covered Put

Covered Put

Post By - Manav Saini
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Covered Put

Description - Covered Put

The concept is that in shorting the stock, you then sell an Out of the Money put option on a monthly basis as a means of collecting rent (or a dividend) while you are short the stock.
The Covered Put is a bearish income strategy, where you receive a substantial net credit for shorting both the put and the stock simultaneously to create the spread.
Short sell the stock.
Sell puts one strike price out of the money [OTM] (i.e., puts with a strike price lower than the stock).

Introduction to Covered Put

Outlook

With a Covered Put, your outlook is neutral to bearish. You expect a steady decline.

Net Position

This is a net credit transaction because you are selling the stock and taking in a premium for the sold put options.
Your maximum risk is unlimited if the stock price rises.

Effect of Time Decay

Time decay is helpful to your trade here because it should erode the value of the put you sold.
Provided that the stock does not hit the strike price at expiration, you will be able to retain the entire option premium for the trade.

Time Period to Trade

Sell the puts on a monthly basis.

Breakeven = [Shorted stock price + put premium]

Steps to Trading a Covered Put

Steps In

Try to ensure that the trend is downward or range bound and identify a clear area of resistance.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
If the stock closes below the strike at expiration, you will be exercised. You will have to buy back the stock at the strike price, having profited from both the option premium you received and the fall in stock price to reach the lower strike price.
If the stock remains above the strike but below your stop loss, let the put expire worthless and keep the entire premium. If you like, you can then write another put for the following month.
If the stock rises above your stop loss, then either buy back the stock (if you’re approved for naked put writing) or reverse the entire position (the put will be cheap to buy back).

Exiting the trade - Covered Put

Exiting the Position

If the share falls below the strike price, you will be exercised and therefore make a limited profit.
If the share rises above the strike price (plus premium you received), you will be losing money.

Mitigating a Loss

Either buy back the share or buy back both the share and the put option you sold.

Advantages and Disadvantages

Advantages

Generate monthly income.
Can profit from range bound or bearish stocks with no capital outlay.

Disadvantages

Capped upside if the stock falls.
Uncapped downside if the stock rises.

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