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Covered Put

A Covered Put is a slightly bearish strategy involving a short position in the underlying stock and a short put. This strategy results in a net premium received (credit) upon initial order entry due mainly to the short stock position.

Uses

Investors often consider this strategy when the market outlook is neutral to slightly bearish. Covered puts can be implemented with a more bearish bias or more upside protection by writing a put that is more out-of-the-money (bearish) or more in-the-money (for upside protection). Because of the short stock position, this strategy requires a margin account.

Risks

This strategy is considered to have high risk and limited reward. The maximum gain would occur if the stock price decreases and remains below the short put strike price. The maximum gain is calculated by taking the net credit received and subtracting the short put strike price. The maximum loss cannot be measured and occurs when the stock position increases to excessive levels.

Upward price movement in the stock is the largest risk associated with this strategy and should be the primary focus of the investor. Also, with covered puts, the investor limits profit potential and will not participate in large gains below the short strike price of the put written.

Increasing implied volatility can have a negative impact on this strategy, but is normally not a concern if the strategy is to be held through expiration.

Time decay has a very favorable effect on this strategy.

Options traders have assignment risk on this trade. Early assignment (American Style) on the short strike price could occur, especially when the strike price is in-the-money. When these risks are a concern, the best course of action may be to close the strategy prior to potential assignment.


Important Note: Options involve risk and are not suitable for all investors. For more information, please read the Characteristics and Risks of Standardized Options.

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