A short put option strategy is simply the sale of a put on a stock. The goal is to profit from the premium paid for the put. The assumption of the trader selling the put is that the price of the stock will go up or at least not fall. Professional traders who routinely sell puts tend to make more money than those who routinely buy puts. But, the possibility of an occasional huge loss tends to limit this practice to traders and trading operations backed by substantial assets. The vast majority of options traders combine puts and calls in such a way as to limit their risk while seeking a profit in options trading.
What Is a Short Put vs a Long Put?
In the world of options trading a short put is one that you sell and a long put is one that you buy. A short put starts with a profit but carries the risk of a loss. A long put starts with a debit but holds the potential for profit. When a trader sells a put, they are paid a premium. They give to the purchaser of the put the right to sell a stock at the strike price of the option contract at any time until the contract expires. If the price of the stock falls dramatically, the buyer will exercise the contract and the seller, the person who is short, must buy from them at the strike price but will then have paid significantly more for the stock than it is currently worth.
What Is the Difference Between Shorting and a Put Option?
Short selling and purchasing puts are both bearish strategies meant to profit when the price of a stock falls. In the case of short selling, the trader sells a stock that they do not have. They borrow it and will need to in order to purchase to return it. If the stock falls in price like they think it will, they can purchase the stock at its current (lower) price and pay back for less thus earning a profit. If their assessment is wrong and the price goes up, they will need to buy the stock for a higher price and will lose money. When the same trader buys a put, they pay money to begin with. If the stock price goes up their loss is limited to the option premium. If it falls, they can exit the contract with a profit. The bottom line is that by purchasing a put option you can limit your risk to the price of the option premium and when buy short the stock you have potentially a huge risk of loss.
How Do You Manage a Short Put Option Strategy?
The most common approach to protecting yourself from loss when selling a put is to purchase a call at a reasonable distance up from the strike price of your put and the current stock price. This approach will reduce your initial credit eventual profit from the trade but will protect you from huge losses if stock volatility takes the price far upward. This a version of a covered straddle and is the way most professional options traders work. This sort of approach allows you to avoid catastrophic loss in return for limiting your potential profit with an options trade. When you work with Top Gun Options you will learn where to apply the various mixed call and put approaches in search of profits. You will be able to watch professional traders in action and receive professionally designed trade setups likely to generate reliable profits whether such a setup involves a short put option strategy or not.