Selling a Put Option

By selling a put option (short put), you are taking on an obligation to accept (buy) 100 shares of an underlying.  To review the definition of a short put, please refer to ”Introductions to Options“.

The short put is an UNLIMITED RISK strategy with limited reward potential and has a bullish trading bias. For selling a put option, you receive a credit (premium).

Example:  Let’s say you form a bullish opinion on JPM (JP Morgan Chase – Bank) through your analysis and decide to sell a put option.  With JPM at $43, you decide to sell the 45 put for a credit of $3.00, meaning that you will keep $300 if the trade works in your favor (JPM > $45 @ Exp).

You have just taken on the obligation to accept (buy) 100 shares of JPM at $45.  As long as JPM trades above $45 by expiration, the short put position will work in your favor as you will get to keep the full credit of $300.  However, if JPM makes a move to the downside from $43, then your position could be in trouble.  Because as a seller, you have the obligation to accept JPM stock at $45 regardless of its current stock price on the open market.

Let’s take a look at the risk profile (@ expiration) to fully understand how the short put position functions.

The short put position starts to lose money after it hits the strike price of $45, but the premium (credit) you receive for selling the put option offsets that loss to some degree.  Therefore, the breakeven point for a short put position is the strike price minus the premium received, which in this case will be $42.

JPM can trade down to $42 by expiration and you will breakeven on the trade, but if it drop below that point, then the position will lose money.

Here is a summary of the Short Put Option:

• Limited Reward (Credit received)
• Unlimited Risk
• Breakeven = Strike Price — Option Premium

A short put strategy is very useful when used correctly and I will share those trading techniques in the “advanced strategies” section of the site.