An investor might use a short put option position when the share price or market is expected to rise.
An investor selling a put option receives a fixed premium and gives another investor the right but not the obligation to sell an asset at a predetermined price until expiration. A Short Put strategy might be considered by a risk-tolerant trader with the opinion that a stock’s price is likely to increase and/or volatility is likely to decrease. The put seller benefits from the passage of time and decreasing dividends. The maximum gain is the premium received, which occurs at any price above the strike price. The gain diminishes as the price of the underlying falls below the strike price. Breakeven occurs at the sum of the strike price less the premium received. At any price below that, the short put seller begins to lose money penny-for-penny as the underlying price decreases. Loss potential is substantial. Short put sellers must ensure that they are sufficiently capitalized to deliver any required shares.
Short Put Example:
- Underlying XYZ stock price: $60.25
- Put strike price:57.50
- Put option premium:$2.00
- Days to expiration:90
- Breakeven: 57.50-$2.00=$55.50 (Strike price minus premium received for put option)
- Profit potential: Limited to the premium received from the sale of the put option at any price at and above the strike price.
- Potential profit: @$60.00 – The put option is out-the-money at expiration and worth zero to someone who sold it for $2.00.
- @$57.50 – The put option is at-the-money at expiration but has zero intrinsic value and is still worthless to someone who sold it for $2.00.
- @54.00 – The put option is in-the-money at expiration and has intrinsic value.
- Its worth is $3.50 and creates a loss to someone who sold it for $2.00 of $1.50. ($54.00 – 57.50 +$2.00 = -$1.50)
- Maximum loss: Limited by the fact that the stock can only fall to zero. However, the investor starts to lose money at the strike price less the premium received (57.50 minus $2.00 = $55.50) and continues to lose penny-for-penny as the share price declines further.
Market Outlook – Bull
Volatility View – Premium decreases
Time Erosion – Premium decays
Dividends – Premium decreases
Interest Rate – Premium increases
Profit Potential – Limited
Loss Potential – Substantial
Components- Sell put option
|Underlying Stock||$ 60.25||Underlying Stock||Profit & Loss|
|Long Call Strike||$ 57.50||$ 10.00||$ (4,550.00)|
|Premium||$ 2.00||$ 20.00||$ (3,550.00)|
|$ 25.00||$ (3,050.00)|
|$ 30.00||$ (2,550.00)|
|$ 35.00||$ (2,050.00)|
|$ 40.00||$ (1,550.00)|
|$ 45.00||$ (1,050.00)|
|$ 50.00||$ (550.00)|
|$ 55.00||$ 50.00|
|$ 57.50||$ 200.00|
|$ 60.00||$ 200.00|
|$ 70.00||$ 200.00|
|$ 80.00||$ 200.00|
Disclosure: Interactive Brokers
The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
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