COVERED
PUT
This strategy
is opposite to a Covered Call. A Covered Call is a neutral to bullish strategy,
whereas a Covered Put is a neutral to Bearish strategy. You do this
strategy when you feel the price of a stock / index is going to remain range
bound or move down. Covered Put writing involves a short in a stock / index
along with a short Put on the options on the stock / index.
The Put that
is sold is generally an OTM Put. The investor shorts a stock because he is
bearish about it, but does not mind buying it back once the price reaches
(falls to) a target price. This target price is the price at which the investor
shorts the Put (Put strike price). Selling a Put means, buying the stock at the
strike price if exercised (Strategy no. 2). If the stock falls below the Put
strike, the investor will be exercised and will have to buy the stock at the
strike price (which is anyway his target price to repurchase the stock). The
investor makes a profit because he has shorted the stock and purchasing it at
the strike price simply closes the short stock position at a profit. And the
investor keeps the Premium on the Put sold. The investor is covered here
because he shorted the stock in the first place.
If the stock
price does not change, the investor gets to keep the Premium. He can use
this strategy as an income in a neutral market. Let us understand
this with an example .
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When to Use: If the investor is of the
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Example
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view that the markets are moderately
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Suppose ABC Ltd. is trading at Rs 4500 in
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bearish.
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June. An investor, Mr. A, shorts Rs 4300 Put
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Risk: Unlimited if the price of the stock
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by
selling a
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July Put for
Rs.
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24 while
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shorting an ABC Ltd. stock. The net credit
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rises substantially
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received by Mr. A is Rs. 4500 + Rs. 24 = Rs.
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Reward: Maximum is (Sale Price of
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4524.
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the Stock – Strike Price) + Put Premium
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Strategy : Short Stock + Short Put Option
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Breakeven: Sale Price of Stock +
Put
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Sells Stock
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Current Market
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4500
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Premium
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(Mr. A
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Price (Rs.)
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receives)
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Sells Put
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Strike Price (Rs.)
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4300
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Premium (Rs.)
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24
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Mr. A receives
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Break Even Point
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4524
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(Rs.) (Sale price of
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Stock + Put
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Premium)
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The
payoff schedule|
ABC Ltd.
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Payoff from
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Net Payoff
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closes at
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the stock
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from the Put
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Net Payoff
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(Rs.)
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(Rs.)
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Option (Rs.)
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(Rs.)
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4000
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500
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-276
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224
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4100
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400
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-176
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224
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4200
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300
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-76
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224
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4300
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200
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24
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224
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4400
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100
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24
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124
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4450
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50
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24
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74
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4500
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0
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24
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24
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4524
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-24
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24
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0
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4550
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-50
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24
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-26
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4600
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-100
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24
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-76
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4635
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-135
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24
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-111
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4650
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-160
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24
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-136
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The payoff chart (Covered Put)
+ =
Sell Stock Sell Put Covered Put
