Covered
Put
Description
The
covered put strategy is just the opposite of the covered call strategy.
You
sell short the stock to cover the put that is written.
When
the stock drops, the investor will have the stock put to them at the short put
strike price. This covers the obligation of the shares of stock that were
shorted. The investor keeps the initial premium received from selling the put.
If
the stock rises the investor keeps the premium, but they are still holding the
short stock obligation and could sustain a loss to close the short. If the
short put does expire, the investor could look to sell another put at a
different strike for
the
next expiration month.
Market
Opinion
Neutral
to bearish.
P/L
When
To Use
Use
this strategy when you are bearish and want to short a stock to earn income
from selling puts. You make money if the stock falls.
Example
XXXX
is trading t $50 on February 25, 2011.
Sell
short the stock for $49.5.
Sell
March 2011 45 strike put for $1.50.
Benefit
You
can generate monthly income from a bearish outlook/position with no money.
Risk
vs. Reward
There
is unlimited risk if the stock goes up in price. The reward is generating
monthly income.
Net
Upside
Shorted
stock price minus strike price plus premium from put.
Net
Downside
Unlimited
downside.
Break
Even Point
Shorted
stock price plus premium from put
Effect
Of Volatility
N/A
Effect
Of Time Decay
Positive
as it erodes the value of the put sold.
Alternatives
Before Expiration
If
the stock stays above the strike but below stop loss, you can let the put
expire worthless and keep the premium.
If
the stock rises above stop loss, you can buy back the stock or reverse the
position.
Alternatives
After Expiration
You
will be exercised at expiration if the stock closes under the strike. Buy back
the stock at the strike price because you have profit from both the premium and
the fall in the stock price which hit the lower strike price.
