Short Put

What Is a Short Put?

A short put alludes to when a trader opens an options trade by selling or [writing](/composing an-option) a put option. The trader who buys the put option is long that option, and the trader who composed that option is short.

The writer (short) of the put option gets the premium (option cost), and the profit on the trade is limited to that premium.

Essentials of the Short Put

A short put is otherwise called an uncovered put or a naked put. Assuming an investor composes a put option, that investor is committed to purchase shares of the underlying stock if the put option buyer [exercises](/work out) the option.

The short put holder could likewise face a significant loss prior to the buyer working out, or the option lapsing, if the price of the underlying falls below the strike price of the short put option.

Short Put Mechanics

A short put happens in the event that a trade is opened by selling a put. For this action, the writer (seller) gets a premium for composing an option. The writer's profit on the option is limited to that premium received.

Starting an option trade to open a position by selling a put is not the same as buying an option and afterward selling it. In the last option, the sell order is utilized to close a position and lock in a profit or loss. In the former, the sell (composing) is opening the put position.

On the off chance that a trader starts a short put, they probably accept the price of the underlying will remain over the strike price of the written put. Assuming the price of the underlying stays over the strike price of the put option, the option will terminate worthless and the writer will keep the premium. Assuming that the price of the underlying falls below the strike price, the writer faces likely losses.

A few traders utilize a short put to buy the underlying security. For instance, expect you need to buy a stock at $25, yet it right now trades at $27. Selling a put option with a strike of $25 means assuming the price falls below $25 you will be required to buy that stock at $25, which you wanted to do at any rate. The benefit is that you received a premium for composing the option. On the off chance that you received a $1 premium for composing the option, you have successfully discounted your purchase price to $24. In the event that the price of the underlying doesn't drop below $25, you actually keep the $1 premium.

Risks of Selling Puts

The profit on a short put is limited to the premium received, yet the risk can be critical. While composing a put, the writer is required to buy the underlying at the strike price. In the event that the price of the underlying falls below the strike price, the put writer could face a huge loss.

For instance, on the off chance that the put strike price is $25, and the price of the underlying tumbles to $20, the put writer is facing a loss of $5 per share (less the premium received). They can close out the option trade (buy an option to offset the short) to understand the loss, or let the option lapse which will make the option be practiced and the put writer will possess the underlying at $25.

Assuming that the option is practiced and the writer needs to buy the shares, this will require an extra cash outlay. In this case, for each short put contract the trader should buy $2,500 worth of stock ($25 x 100 shares).

Short Put Example

Accept an investor is bullish on theoretical stock XYZ Corporation, which is right now trading at $30 per share. The investor accepts the stock will consistently rise to $40 over the course of the next several months. The trader could buy shares, yet this would require $3,000 in capital to buy 100 shares. Composing a put option produces income right away, yet could make a loss later on in the event that the stock price falls (as could buying the shares).

The investor thinks of one put option with a strike price of $32.50, terminating in 90 days, at $5.50. In this manner, the maximum gain is limited to $550 ($5.50 x 100 shares), which happens if the stock closes at $32.5 or higher at expiration. The maximum loss is $2,700, or ($32.50 - $5.50) x 100 shares. The maximum loss happens if the underlying tumbles to zero and the put writer is assigned to buy the shares at $32.50. The maximum loss is somewhat offset by the premium received from selling the option.

Features

• Thus, a decline in price will cause losses for the option writer.
• The thought behind the short put is to profit from an increase in the stock's price by gathering the premium associated with a sale in a short put.
• A short put is the point at which a trader sells or composes a put option on a security.