The short put holder could also face a substantial loss before the buyer exercises or the option expires if the price of the underlying falls below the strike price of the short put option.
Short Put Strategy
A Short put is another bullish trading strategy wherein your view is that the price of an underlying will not move below a certain level. The strategy involves entering into a single position of selling a put option. It has less profit potential and is exposed to unlimited risk. A Short put strategy involves selling a put option only.
For example, if you see that the shares of company A will not move below Rs1000, then you sell the put option of that stock at Rs1000 and receive the premium amount. The premium received will be the maximum profit you can earn from this trade.
On the other hand, if the price of the underlying moves below 1000, then you will incur unlimited losses. Short put works well when you're sure that the price of the underlying will not fall beyond a certain level.
Risk and Reward
There is no limit to losses incurred in the trade. The risk is when the price of the underlying falls, and the Put is exercised. You are then obliged to buy the underlying at the strike price. The profit is limited to the premium received in your account when you sell the Put Option.
Example
Suppose you’re a bullish investor trading on the stock of ABC Corporation, which is currently trading at 1000 Rs per share. But you predict that this share will rise to 1100 in a few months.
You buy a particular number of shares expecting a rise. But, to buy 100 shares, you would require an amount you may have yet to be liquidly available. In such cases, a Put option will generate income for you immediately, but it could lead to significant potential losses in the future.
Suppose you write a Put option of Rs. 1025 expiring in 3 months at Rs. 200. Your maximum gain is now limited to Rs. 20,000 (Rs. 200 x 100 shares), which will occur if the price closes at or higher than the strike price of Rs. 1025 at the time of expiration.
However, your maximum loss can be much higher- Rs. 82500 (1025 - 200 Rs) x 100 shares. This maximum loss will only occur if the value of your underlying falls to an absolute zero and the Put writer is assigned to buy the shares at Rs. 1025 per share.
This is why adequate knowledge and research are required while placing a short put in options. You have limited potential upside and a much larger potential downside in case your purchased option falls below the strike price.
Short Put Option
A Short put meaning is the sale of a regular Put Option. When a trader is shorting a Put option, they sell the rights to short the options underlying stock any time before the expiration of the option - at the Strike Price.
The entire goal of the short put is to earn by receiving the options premium without utilising it. The options seller can incur a loss from a short put option if the buyer decides to exercise it, as the seller is required to purchase the underlying stocks at the strike price. Thus, one of the primary risks associated with short put is the price of the stock or underlying asset falling below the strike price.
Short put options can be an unfavourable option for those with no experience in the Options market as the profit is limited to the amount of premium on selling it.
For example, let’s say the strike price is Rs 100 and the price of the underlying falls to Rs 90. The Put writer will face a loss of 10 Rs per share when shorting the Put. At this point, they have a couple of options to look out for - they can either close out the option trade (buy an option to offset the short) to realise the loss or let the option expire, which will cause the option to be exercised. The Put owner will own the underlying asset at Rs 100.
Conclusion
In conclusion, a short put obligates the seller to buy the underlying stock if the buyer exercises the option. While providing immediate income, it carries significant risks, especially if the stock price falls below the strike price. Adequate research and caution are essential in short put trading.
