A short covered put is an options strategy that involves both stock and an options contract. The trader sells stock, and then sells a put contract, and then waits for the options contract to be exercised or to expire. If the options contract is exercised (at any time for US options, and at expiration for European options) the trader will buy the stock (from the holder of the put contract) at the strike price. In a short covered put, the put can be an in the money or at the money put, where the profit would be the premium received for the put, or an out of the money put, which allows for profit to be made on both the premium and the difference between the stock and strike prices.
Making a Short Covered Put
- Sell stock
- Sell a single put contract
- Wait for the put to be exercised or to expire to realize the profit
Risk and Reward
As shown on the risk / reward chart (view the full size chart), the risk of a short covered put is high, as there is no protection if the stock price moves significantly upward (against the stock trade). The risk of a short covered put is calculated as :
Maximum Risk = Unlimited
Loss = Price of Stock - Purchase Price of Stock - Premium Received
The reward of a short covered put is limited to the premium received for the put (for an at the money, or in the money put), or to the difference between the stock and strike prices plus the premium received for the put (for an out of the money put). The profit of a short covered put is calculated as :
Maximum Profit = Limited
Profit = Purchase Price of Stock - Strike Price + Premium Received
