Covered Put – is one of the risk free trading strategies with the application of option contracts. The main idea of the strategy is the following – a person should sell put options with a simultaneous opening of a short-term call position or have covered funds on an account commensurable to a strike price of the option. In this particular strategy, an option seller is a holder of a basic asset. When making a trade, a buyer/seller is offered a right to buy/sell a bespoken stock instrument under the terms and conditions which are written in an agreement.
Covered Put: the Principle
In trades with option contracts, such covered calls as covered put – is one of the best strategies and the reason for that is clear – is it is absolutely risk free. Its main principle is based on an idea that selling of a put option contract against opening a short-term trade with a base option is first of all profitable and second of all riskless concept.
Peculiarity – it is a great opportunity for traders who sell short to receive an additional income. The strategy is modern and up-to-date for neutral (sideways) or decreasing (bear) market. Favorable conditions for making a trade – gradual decrease of an asset basic price.
Profit – the profit from using this particular strategy depends on the main factor which is – the ability of an option contract to decrease the price when the expiration day comes. It doesn’t make sense to exercise the contract when the expiration is very close. It is way better and profitable to exercise it when there are still many days before the contract expiration.
Sell – it is not recommended to sell a covered put if there are more than 1,5 months until the expiration. Such a long period of time is capable of bringing high risks in terms of market price move to such a figure that a put option will not be able to compensate with the help of a short-term position.
Breakeven Result – in trades with a covered put, breakeven point is considered to be a sum of the basic price of an option contract at the moment of opening a short-term position and a premium.
To conclude, one can summarize that covered put is a risk free strategy, which implies a selling process of a put option by using a short-term position or availability of a certain amount of money on an account which should be enough to cover an option exercising. In this situation an option seller is an owner of a basic asset. With the right and proper approach, the concept is very profitable and effective.