As an options seller, a trader wants option prices to decrease. Let's go over the strategy's general characteristics: Put Sale Price Credit Received x Put Strike Price - Credit Received x Put Strike - Credit Received.
Estimated Probability of Profit: When the short put is in-the-money, the short put trader is at risk of being assigned shares of stock per put contract. The probability of assignment is more significant when the put is in-the-money with very little extrinsic value. In the following example, we'll construct a short put from the following option chain: The following visual describes the potential profits and losses at expiration for this short put position: The put has no intrinsic value , and therefore expires worthless.
Consequently, the short put position is profitable. The put option's intrinsic value is now greater than the premium the trader collected when selling the put, and therefore the short put position is not profitable.
The company has gone out of business. The last thing we'll point out about this graph is that the breakeven price is below the current stock price. Because of this, selling puts is a high probability strategy.
However, this makes sense since the maximum potential loss is greater than the maximum potential reward. So, you know how the outcomes at expiration when selling puts, but what about before expiration? The following table describes the Greek exposures of a short put position: Conversely, put prices rise when the stock price increases, which is bad news for put sellers. Negative - Increases in implied volatility indicate an increase in option prices, which is detrimental to put sellers.
When selling put options, a trader's best friend is the passage of time. As time passes, the extrinsic value of options decays away, leading to profits for option sellers. However, this assumes there are no harmful changes in the stock price or implied volatility.
To be profitable when selling puts, large decreases in the stock price or increases in implied volatility must not occur in short time periods. Regarding directional movements, negative gamma is something to be aware of when selling put options.
As you can see, negative gamma causes a growth in directional risk when the stock price moves against a short put position. You've learned the general characteristics of the put selling strategy. Now, let's go through some visual examples to solidify your knowledge of how short puts work.
Note that we don't specify the underlying, since the same concepts apply to all stocks in the market. The first example we'll look at is a situation where a trader sells an at-the-money put option strike price near the stock price. Here are the specifics: Let's see what happens! As you can see, selling puts is profitable as long as the stock price doesn't fall quickly and violently.
Three factors contribute to the put's price decrease: All three of these occurred in this trade example. Regarding closing this position early, the trader in this example had many opportunities to close the put before expiration to lock in profits.
To close a short put, a trader can buy back the put at its current price. Next, we'll look at an example of a short put trade where the stock price is below the put's strike price at expiration. When the stock price is below a short put's strike price at expiration, the put seller will not make the full profit potential. However, it is still possible that the trade could work out. To demonstrate this, let's look at an example where the stock price is trading below the short put's strike price at expiration.
Let's take a look at the trade's performance: Letting an option expire in-the-money is known as "taking assignment. However, keep in mind that it's always possible to be assigned shares of stock on an in-the-money short put, but unlikely when the put has plenty of extrinsic value.
Alright, you know how well short puts can do. Let's finish by investigating what can go wrong when selling puts. So, what happens when the stock price falls through the strike price of a short put? To demonstrate this, we'll look at a situation where a trader sells an at-the-money put before the stock price drops significantly.
Here are the specifics of the next example: In the first 14 days of this trade, the short put trader didn't have significant profits or losses. As mentioned earlier, it's always possible to close the position early to lock in losses. In summary, keep in mind that things don't always work out when trading a high probability strategy such as selling puts. However, there's always an exit opportunity if the losses get out of hand.
Be sure to read the summary of key points below! Selling put options is a strategy used by traders who have a bullish outlook for a particular stock. Selling a put option has more loss potential than profit potential, but that translates to a higher probability of profit.
A trader who sells a put option benefits from increases in the stock price, decreases in implied volatility, and the decay of the put's extrinsic value as time passes. To close a short put before expiration, a trader can buy back the put at its current price to lock in profits or losses. At expiration, a short put position is profitable when the put's intrinsic value is less than the trader collected for selling the option.
Short Put Trade Examples [Visual]. Summary of Main Concepts. Stock Price at Zero The company has gone out of business. Vega Negative - Increases in implied volatility indicate an increase in option prices, which is detrimental to put sellers.More...