Covered Put
Short 100 shares and sell a put against them. A bearish income strategy that collects premium while holding a short stock position.
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What is a Covered Put?
A covered put is the bearish mirror image of a covered call. You short 100 shares of a stock and then sell a put option against that short position. You collect premium for selling the put, and in exchange you agree to buy back the shares at the strike price if the stock drops below it by expiration. Your short stock position "covers" the obligation of the short put.
This strategy is used by traders who are bearish on a stock and want to generate extra income while holding a short position. It is less common than the covered call because shorting stock carries more risk, but the mechanics are identical in reverse.
How to Set It Up
- Short 100 shares of the underlying stock
- Sell 1 put option at a strike price below the current stock price
- Strike selection: Sell OTM puts. The further OTM, the less premium you collect, but the more room you give the stock to drop before you get assigned. A strike 5-10% below current price is a reasonable starting point.
- Expiration: 30-45 days out is the sweet spot for time decay.
You collect the premium immediately. That premium is yours regardless of what happens next.
When to Use This Strategy
Use a covered put when:
- You are already short shares and want to generate income on the position
- You believe the stock will stay flat or decline slightly
- You are willing to cover your short at the strike price if the stock drops past it
- You want to lower the effective entry price on your short position over time
Do not sell covered puts if you expect a massive downside move. You would be capping your gains right when the stock is crashing in your favor.
Example Trade
You short 100 shares of XYZ at $100 per share.
- Sell 1 XYZ $95 put expiring in 30 days for $2.00
- Premium collected: $2.00 x 100 = $200
Scenario 1: XYZ stays at $100. The put expires worthless. You keep your short and the $200. Sell another put next month.
Scenario 2: XYZ drops to $90. You get assigned on the put and buy back shares at $95. You made $5 per share ($500) on the short plus $200 in premium = $700 total profit. You miss the extra move from $95 to $90, but $700 on a $10,000 short position in 30 days is excellent.
Scenario 3: XYZ rises to $105. The put expires worthless. You keep the $200, which reduces your loss on the short. Without the covered put, you would be down $500. With it, you are down $300.
Risk and Reward
- Max profit: (Short sale price - strike + premium) x 100. Capped at the strike. In our example, $700.
- Max loss: Theoretically unlimited. If the stock keeps rising, your short loses money. The premium helps offset some of the loss, but it does not protect you from a big rally.
- Breakeven: Short sale price plus premium. In our example, $100 + $2 = $102. The stock can go up to $102 before you start losing money.
The premium collected lowers your breakeven on the short, giving you a small cushion against upward moves.
Tips and Common Mistakes
- Remember that shorting stock has unlimited risk. The covered put does not eliminate this risk. If the stock doubles, you are in serious trouble.
- Do not sell puts too close to the money just for the higher premium. You will get assigned constantly and miss big downside moves.
- Use stop losses on the overall position. Since your upside risk is unlimited, have a plan for when the trade goes against you.
- This requires margin. Shorting stock and selling puts both require a margin account with sufficient buying power.
Related Strategies
- Covered Call — the bullish version: own shares and sell a call
- Short Put — sell a put without the short stock position
- Bear Put Spread — a defined-risk bearish alternative
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