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Covered Put
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. The analogy to the covered call is:
| Covered Call |
Covered Put |
| Buy the stock |
Short the stock |
| Collect premium on write of call |
Collect premium on write of put |
| Risk is if stock goes down |
Risk is if stock goes up (because of short) |
| If called deliver stock owned |
If assigned deliver stock to pay short |
Example:
The covered put strategy is a neutral to bearish strategy because the investor is expecting the stock to go down or stay neutral. 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 worthless without assignment, the investor could look to sell another put at a different strike for the next expiration month.
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- Write (Sell) the OCT 25 (ATM) Put at $1.90
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| Break Even = |
Short Stock Price + Option Bid = $26.57 |
| Maximum Profit = |
[(Short Stock Price - Strike Price) + Option Bid = $1.57 |
| % Downside Protection = |
Option Bid ÷ Short Stock Price = 7.7% |
| % if Assigned = |
Max Profit ÷ (Short Stock Price - Net Credit) = 6.9% (If stock below $25 at exp.) |
Notes and references
- http://www.poweropt.com/cphelp.asp
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