January 2022

Short Call Option Strategy: Guide With Visuals Graphs

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 01:46 pm

The “short call” options strategy (selling a call option) is a bearish options strategy that consists of selling a call option on a stock that a trader believes will decrease in price (or not increase to a level above the call’s strike price before expiration).

TAKEAWAYS

The short call is best suited for bearish and neutral markets.
The maximum profit here is the total credit received.
Maximum loss on a short (naked) call is unlimited.
Breakeven for short calls is strike price + credit received.
Short calls can profit in any market, including minorly bullish markets.

Short Call Strategy Characteristics

Let’s go over the strategy’s general characteristics:

➟Maximum Profit Potential: Credit Received x 100

➟Maximum Loss Potential: Unlimited

➟Expiration Breakeven Price: Call Strike Price + Credit Received

➟Estimated Probability of Profit: Greater than 50%

Profit/Loss Potential at Expiration

In the following example, we’ll construct a short call position from the following option chain:

In this case, we’ll sell the 100 call for $10. Let’s also assume that the stock price is trading for $100 when we sell the call option.

Initial Stock Price: $100

Call Strike Price: $100

Call Sale Price: $10

If a trader sells this call option, their potential profits and losses at expiration are described by the following visual:

Covered Call Profit/Loss

The following table describes various scenarios of this short call position at expiration:

Stock Price Below the Short Call Strike (Below $100):

The call expires worthless, and therefore the short call trader realizes the maximum profit potential of $1,000.

Stock Price Between the Short Call Strike and the Breakeven Price (Between $100 and $110):

The call expires with intrinsic value, but not more than the initial $10 sale price of the call. As a result, the short call trader realizes partial profits at expiration. If the call is held through expiration, the trader will be assigned -100 shares of stock per call contract.

Stock Price At Breakeven Price (At $110):

The call expires with $10 of intrinsic value. Since the call was initially sold for $10, the short call trader breaks even. If the call is held through expiration, the trader will be assigned -100 shares of stock per call contract.

We’ve just covered the basics of the short call options strategy. Next, let’s take a look at some real trade examples to see the strategy’s performance in different historical scenarios.

Short (Naked) Call Trade Examples

To visualize the performance of various short call positions, let’s look at a few real examples. Before we start, it’s important to note that the specific stock will not be specified, as the concepts in each example are transferable to other stocks.

Additionally, each example assumes a size of one call contract. To convert the profits and losses to a larger position, just multiply the profits and losses by an increased number of call contracts.

Trade Example #1: Profitable Short Call Trade

The first example we’ll look at is a scenario where an out-of-the-money call is sold, the stock price gradually increases towards the short strike, but the trade works out in the end.

Here are the trade details:

Initial Stock Price: $119.94

Initial Implied Volatility: 23%

Call Strike and Expiration: 125 call expiring in 71 days

Call Sale Price: $1.52

Call Breakeven Price: $125 call strike + $1.52 credit received = $126.52

Maximum Profit Potential: $1.52 credit received x 100 = $152

Maximum Loss Potential: Unlimited

Let’s see how the trade performed:

Short Call #1 Trade Results

As we can see in this example, the stock price gradually increased from $120 to $126, and the short 125 call never experienced significant losses. In fact, with 11 days to expiration, the stock price was actually above the short call’s strike price of $125, and the position had small profits.

Overall, the stock price increase was gradual, and time decay was able to fight against any directional losses. Additionally, implied volatility fell from 23% to 16% over the entire period, which also helped the short call position (implied volatility change not visualized here).

The decrease in the call’s price from $1.52 presented the short call trader with many opportunities to buy back the call for a profit before expiration. For example, around 40 days to expiration, the 125 call’s price fell below $0.75, which represents a $77 profit for the call seller at that moment. To lock in the profit/loss at any given moment, a short call trader can just buy back the call they are short.

If the trader decided to hold the short call position, they would have been just fine. At expiration, the stock price was below the short call’s strike price, and the option expired worthless. Because of this, the hypothetical short call trader realized the maximum profit of $152.

Trade Example #2: Significant Short Call Loss

In the previous example, we examined a gradual stock price increase. In this next example, we’ll look at a situation where the stock price unexpectedly gaps up through the short call strike.

Here are the trade details:

Initial Stock Price: $52.58

Call Strike and Expiration: 60 call expiring in 43 days

Call Sale Price: $2.28

Call Breakeven Price: $60 call strike + $2.28 credit received = $62.28

Maximum Profit Potential: $2.28 credit received x 100 = $228

Maximum Loss Potential: Unlimited

Let’s see what goes wrong:

Short Call #2 Trade Results

As we can see here, the short 60 call was nearly worthless in the first 30 days because the stock price fell as time passed.

However, with around 13 days to go, the stock price gapped up from $50 to $90. As a result, the 60 call went from being worth $0 to over $32. Why? As the share price increases further and further above the call’s strike price, the call’s ability to purchase shares of stock at the lower strike price becomes more valuable, resulting in a higher call price.

With an initial sale price of $2.28, the short call’s price rising to $32 translates to a loss of $2,972 for the short call trader. This example serves as a demonstration of the significant risk involved with selling a call option.

In reality, it’s unlikely that a trader who sold this call didn’t close the position before the gap up in the stock price. As we can see, the call was nearly worthless between 30 and 14 days to expiration, presenting a 16-day window to close the call for near the maximum profit before the large upside move.

When selling options, the cheaper the option price gets, the less reward there is to be made, but there’s still all of the risk. In the event the option’s price gets close to $0, it becomes very logical to close the position and secure the profits to eliminate the potential of a big reversal (and therefore big losses), as exemplified here.

Trade Example #3: Steadily Profitable Call Sale

In the final example, we’ll examine an at-the-money short call position on a stock that remains in a tight range.

Here are the trade details:

Initial Stock Price: $105.13

Call Strike and Expiration: 105 call expiring in 31 days

Call Sale Price: $3.40

Call Breakeven Price: $105 call strike + $3.40 credit received = $108.40

Maximum Profit Potential: $3.40 credit received x 100 = $340

Maximum Loss Potential: Unlimited

Let’s see what happens!

Short Call #3 Trade Results

As we can see in this example, the stock price never gapped up through the breakeven price, but it also never crashed significantly. Because of this, the short call position experienced slow and steady profits through time as the option’s extrinsic value decayed.

At expiration, the stock price was below the short call’s strike price and the call expired worthless, leaving the position with the maximum profit of $340.

Final Word

Congratulations! You’ve made it to the end of the guide. Hopefully, this guide on selling call options has left you feeling much more comfortable with how the strategy works. Let’s go over what we learned:

The short call is a high probability, high risk trade.
Since a stock can in theory go to infinity, the losses on a short call are infinite.
The less credit received for a short call, the less reward.

Next Lesson

Additional Resources

Explaining Call Options (Short and Long) – CME Group

Bear Put Spread Explained – Guide With Visuals

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 01:48 pm

The purchase of a put spread (a “long put spread” or “bear put spread” position) is a bearish options strategy that consists of simultaneously buying a put option and selling the same number of put options at a lower strike price on a stock that a trader believes will decrease in price.

Both options must be in the same expiration cycle.

The strategy builds on a long put position by selling a put at a lower strike price to reduce the cost, and therefore the risk of the trade.

TAKEAWAYS

The bear put spread is a bearish strategy with defined risk.
The inputs of a bear put spread are one long put (higher) strike price and one short put (lower strike price).
This strategy has “defined risk”; maximum loss is the debit paid.
The long put spread maximum profit is the difference between the strike prices, minus the net debit paid.

Bear Put Spread Strategy Characteristics

Here are the strategy’s general characteristics:

➟Maximum Profit Potential: (Width of Put Strikes – Net Debit Paid) x 100

➟Maximum Loss Potential: Net Debit Paid x 100

➟Expiration Breakeven Price: Long Put Strike Price – Net Debit Paid

To better understand each of these characteristics, we’re going to look at a basic example.

Profit/Loss Potential at Expiration

In the following example, we’ll construct a bear put spread from two of the put options in the following options chain:

In order to construct a bear put spread, we’ll have to buy a put while also selling a put at a lower strike price.

In this example, we’ll buy the 130 put for $5.00 and sell the 120 put for $2.00.

Let’s also say that the stock price is trading for $135 at the time of buying the spread:

Initial Stock Price: $135

Put Options Traded: Buy 130 put for $5.00; Sell 120 put for $2.00

Put Spread Purchase Price: $5.00 Paid – $2.00 Received = $3.00 Net Debit

If a trader buys this put spread, their potential profits and losses at expiration are described by the following visual:

Long Put Spread Outcomes

This particular put spread is out-of-the-money because the 130 and 120 puts are both out-of-the-money. As a result, the put spread has a probability of profit less than 50% because the stock price must fall below 130 for the position to have any value at expiration.

Additionally, the maximum profit potential is $700, and the maximum loss potential is $300, which also suggests a lower probability of profit because the reward is greater than the risk.

The following table describes various scenarios of this bear put spread position at expiration:

Stock Price At or Below the Short Put Strike Price (At or Below $120):

Both options of the put spread are fully in-the-money, and since the put strikes are $10 apart, the spread is worth its maximum value of $10 at expiration. With an initial purchase price of $3.00, the put spread buyer realizes the maximum profit potential of $700: ($10 spread price at expiration – $3 spread purchase price) x 100 = +$700.

Stock Price Between the Short Put Strike Price ($120) and the Breakeven Price ($127):

The long 130 put expires with more intrinsic value than the $3.00 purchase price of the spread. Because of this, the put spread buyer is profitable at expiration.

Stock Price At the Breakeven Price ($127):

The long 130 put is worth exactly $3.00 at expiration, and the 120 put expires worthless. As a result, the 130/120 put spread’s final value is $3.00. Since the spread was initially bought for $3.00, the trader realizes no profits or losses.

Stock Price Between the Breakeven Price ($127) and the Long Put Strike Price ($130):

The short 120 put expires worthless, and the long 130 put expires with less than $3.00 of intrinsic value. As a result, the 130/120 put spread’s final value is less than $3.00, which results in losses for the buyer of the put spread.

Stock Price At or Above the Long Put Strike Price ($130):

Both the 130 and 120 put expire worthless, resulting in a $200 profit on the short 120 put, and a $500 loss on the long 130 put. The net loss is $300, which is the maximum loss potential of a spread purchased for $3.00.

Nice job! You know the basics of the bear put spread strategy.

In the next section, we’ll look at real trade examples to show you how the strategy has performed over time in different scenarios.

Bear Put Spread Trade Examples

To visualize the performance of various long put spread positions, let’s look at a few real examples. Before we start, it’s important to note that we won’t specify the stock the trade was on, as the concepts in each case are transferable to put spreads on other stocks in the market.

Additionally, each example uses a size of one put spread. To convert the profits and losses to a larger position, just multiply the profits and losses by the number of spreads.

Trade Example #1: Low Probability Put Spread Purchase

The first example we’ll look at is a scenario where a hypothetical trader buys an out-of-the-money put spread and the stock price gradually decreases.

Here are the trade details:

Initial Stock Price: $207.78

Put Strikes and Expiration: Long 205 Put for $2.10; Short 200 Put for $1.13; Both options expiring in 35 days

Put Spread Purchase Price: $2.10 Paid – $1.13 Received = $0.97 Net Debit/Price Paid

Breakeven Price: $205 Long Put Strike – $0.97 Net Debit = $204.03

Maximum Profit Potential: ($5-Wide Strikes – $0.97 Net Debit) x 100 = $403

Maximum Loss Potential: $0.97 Net Debit x 100 = $97

In this example, the put spread is entirely out-of-the-money when entering the trade. Additionally, the maximum profit potential is $403, while the maximum loss potential is $97. Because of the high reward and low risk, the put spread’s probability of profit is much lower than 50%.

Let’s see how this trade performed:

Long Put Spread #1 Trade Results

As we can see here, the put spread’s value increased as the stock price fell. At around 16 days to expiration, the put spread was trading for $1.50, resulting in an unrealized profit of $53 for the long put spread trader: ($1.50 spread price – $0.97 purchase price) x 100 = +$53. If the trader wanted to take their profits, they could have sold the spread when it was trading for $1.50. Of course, they wouldn’t know that would be the moment of maximum profitability, but the key here is that all option positions can be closed before expiration, in which the profit/loss at that moment will be realized.

If the trader decided to hold the spread until expiration, they would have realized the maximum loss of $97, as the stock price was above both put strikes at expiration.

This example demonstrates that buying out-of-the-money put spreads requires a significant decrease in the stock price to have profits at expiration.

Additionally, even when the stock price falls, the long put spread trader may still lose money due to time decay if the move doesn’t happen quickly.

When the put spread is out-of-the-money, its value will approach $0 as expiration approaches, which is exactly what happened in this example.

Next, we’ll look at a profitable long put spread position.

Trade Example #2: Profitable Bear Put Spread

In the previous example, we examined a gradual stock price decrease after buying an out-of-the-money put spread. In this next example, we’ll look at a situation where the stock price falls significantly after an at-the-money put spread is purchased.

Here are the trade details:

Initial Stock Price: $104.08

Put Strikes and Expiration: Long 115 Put for $15.85; Short 100 Put for $7.35; Both options expiring in 35 days

Put Spread Purchase Price: $15.85 Paid – $7.35 Received = $8.50 Net Debit

Breakeven Price: $115 Long Put Strike – $8.50 Net Debit = $106.50

Maximum Profit Potential: ($15-Wide Strikes – $8.50 Net Debit) x 100 = $650

Maximum Loss Potential: $8.50 Net Debit x 100 = $850

In this example, the purchased put is slightly above the stock price and the sold put is below the stock price, which results in a breakeven price right at the initial stock price. Many traders favor this type of setup because if the stock price doesn’t change, the put spread won’t make or lose much value.

In the previous example, the spread’s value decreased even as the stock price fell because the spread was entirely out-of-the-money at the time of entry, requiring a rapid stock price decrease for the trade to make money.

Let’s take a look at this next spread’s performance!

Long Put Spread #2 Trade Results

In this example, the put spread was profitable almost the entire period because the stock price fell to a level below the short put’s strike price early on.

As time passed, the spread’s value slowly approached its maximum value of $15 (the difference between the 115 put and 100 put’s strike prices).

If you’re wondering why the spread wasn’t maximally profitable right when the stock price fell below the short put’s strike price of $100, it’s because extrinsic value needs to come out of the options for the spread to reach its maximum value.

Decreasing extrinsic value occurs with the passage of time, as the option’s get further and further in-the-money, or a combination of the two.

In the final example, we’ll look at an in-the-money long put spread example.

Trade Example #3:

In the final example, we’ll examine an in-the-money put spread as the stock price increases steadily.

Here are the trade details:

Initial Stock Price: $127.88

Put Strikes and Expiration: Long 132 Put for $4.93; Short 128 Put for $2.13; Both options expiring in 31 days

Put Spread Purchase Price: $4.93 Paid – $2.13 Received = $2.80 Net Debit

Breakeven Price: $132 Long Put Strike – $2.80 Net Debit = $129.20

Maximum Profit Potential: ($4-Wide Strikes – $2.80 Net Debit) x 100 = $120

Maximum Loss Potential: $2.80 Net Debit x 100 = $280

In this case, the 132 put is purchased while the 128 put is sold. This particular put spread is entirely in-the-money since the stock price is below both of the put strikes at trade entry.

Regarding probabilities, the spread’s maximum profit is $120 while the maximum loss is $280. Additionally, the breakeven price is higher than the stock price, which means the share price can rise and the long put spread position can still profit. Both of these factors suggest a probability of profit that is greater than 50%.

Let’s see what happens with this trade:

Long Put Spread #3 Trade Results

As illustrated in this example, the stock price began to rise right after the long put spread position was initiated. Because of this, the put spread’s value fell. In addition to the stock price rising, time decay also played a part in the collapse of the put spread’s value. When the stock price is above the spread’s breakeven price, the price of the spread will decay towards an unprofitable price as expiration approaches.

For example, with the stock price at $131, the spread would be worth $1 at expiration because the 132 put would be worth $1 and the $128 put would be worth $0. However, since the spread was bought for $2.80, the put spread buyer would lose $1.80 on the spread ($180 loss per spread).

At expiration, the stock price was trading for $131.88. Consequently, the 128 put expired worthless and the 132 was worth $0.12. The net loss in this case is equal to: ($0.12 final spread price – $2.80 initial sale price) x 100 = -$268.

Final Word

Well done! You’ve reached the end of the bear put spread strategy guide. Hopefully, you’re now much more comfortable with how the strategy works. Let’s now review what we have learned:

Bear put spreads are also called “long put spreads”.
In order to be a true vertical spread, both options in this strategy must be of the same expiration cycle.
Even when a underlying falls, the long put spread trader may still lose money due to time decay.

Next Lesson

Additional Resources

Bear Put Spread – The Options Industry Council

What is a Long Put Option? (Ultimate Guide with Visuals)

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 01:52 pm

Buying a put option (sometimes referred to as a “long put option”) is a bearish strategy that benefits from a drop in the stock price or an increase in implied volatility. Buying a put option is similar to shorting shares of stock, except buying puts has limited loss potential and a lower probability of profit since the breakeven price will be lower than the current stock price.

TAKEAWAYS

Long put options are very bearish trades.
Max profit on a long put is the strike price (minus) premium paid.
Max loss on a long put is always the debit paid.
The long put is a low probability, high reward trade.

Long Put General Characteristics

➥Maximum Profit Potential: (Put Strike Price – Premium Paid) x 100

➥Maximum Loss Potential: Premium Paid for Put x 100

➥Expiration Breakeven Price: Put Strike – Premium Paid for Put

➥Estimated Probability of Profit: Less than 50%

Expiration Profits/Losses for a Long Put Position

In the following example, we’ll construct a long put position from the following option chain:

In this case, we’ll buy the 150 put for $5.00. Let’s also assume the stock price is trading for $150 when we buy the put.

➥Stock Price: $150

➥Put Strike Price: $150

➥Put Purchase Price: $5

If a trader buys this put option, their potential profits and losses at expiration are described by the following visual:

The following explains each of the scenarios illustrated above:

Stock Price Below the Put Breakeven Price ($145):

The 150 put expires with more intrinsic value than the put buyer paid for the option. Consequently, the trader’s position is profitable.

Stock Price Between the Put’s Breakeven Price and the Put’s Strike Price ($145 to $150):

The 150 put expires with intrinsic value, but not more than the $5 that the trader paid for the option. As a result, the trader realizes partial losses on the position.

Stock Price Above the Put’s Strike Price ($150):

The 150 put has no intrinsic value, and therefore expires worthless. The put buyer realizes the maximum loss potential of $500.

Long Put Option Trade Examples

To visualize the performance of long put positions, let’s look at a few examples of real puts that recently traded. Note that we don’t specify the stocks in each case, as the underlying concepts transfer to other stocks in the market.

Trade Example #1: Buying an At-the-Money Put

The first example we’ll look at is a situation where a trader buys an at-the-money put option (strike price near the stock price).

Here are the trade details:

Initial Stock Price: $77.21

Put Strike and Expiration: 77.5 put expiring in 74 days

Put Purchase Price: $4.95

Put Breakeven Price: $77.5 strike price – $4.95 debit paid = $72.55

Maximum Profit Potential: $72.55 x 100 = $7,255 (stock price goes to $0)

Maximum Loss Potential: $4.95 put purchase price x 100 = $495

In the case of buying an at-the-money put, you’ll notice that the breakeven price is lower than the stock price, which means the stock price must fall for the strategy to be profitable at expiration (and is therefore a low probability trade). If the stock price does not fall quickly enough, the put price will decay slowly until expiring worthless at expiration.

Let’s see what happens!

Long Put #1 Trade Results

As we can see here, the stock price never made the necessary downside move to generate significant profits for the long 77.5 put. Since the stock price was at or above the put’s strike price as time elapsed, the put’s price decayed towards $0. The losses from the passage of time are expressed by the put’s negative theta position.

Additionally, implied volatility fell from 37% to 24% over the trade period, which indicates a significant collapse in option prices on this stock. Because of this, the 77.5 put fell in price from time decay (theta) and a decrease in implied volatility. To offset these two factors, the stock price would have had to fall significantly.

At any point in this trade, the long put trader could have locked in the current profit or loss by selling the put they bought. For example, if the trader sold the put back for $2.50, they would have locked in a loss of $245. On the other hand, if the trader sold the put for $5.50, they would have locked in a profit of $55. So, there’s always an opportunity to close a long put position if you do not wish to be in the trade any longer.

Trade Example #2: Buying an Out-of-the-Money Put

In this next example, we’ll look at a situation where a trader buys an out-of-the-money put option.

Here are the trade details:

Initial Stock Price: $103.40

Put Strike and Expiration: 98 put expiring in 39 days

Put Purchase Price: $1.49

Put Breakeven Price: $98 strike price – $1.49 debit paid = $96.51

Maximum Profit Potential: $96.51 x 100 = $9,651 (stock price goes to $0)

Maximum Loss Potential: $1.49 put purchase price x 100 = $149

Let’s see how this put option performs over time!

Long Put #2 Trade Results

In this example, you can see that the put’s strike price and breakeven is significantly below the initial stock price of $103.40. When buying out-of-the-money puts, quick and significant decreases in the stock price, or increases in implied volatility are required to profit. Fortunately, the stock price fell from $103.40 to nearly $98 in the first 8 days of this trade.

Now, when stock prices fall quickly, implied volatility tends to increase as well because more investors are willing to pay more for insurance. In this case, implied volatility increased from 26% to 31% when the stock price fell from $103.40 to $98. As a result, the price of the 98 put increased from $1.49 to $3.00, which results in a 100% return for the long put trader. However, it’s important to note that these profits are not permanent since the 98 put is still out-of-the-money.

As we can see, from 31 to 14 days to expiration, the stock price was still above the put’s strike price of $98. Because of this, all of the put buyer’s initial profits eroded. Fortunately, the stock price fell again, this time to $95. The put’s price shot up to $3.75 ($3 of it being intrinsic value), creating yet another opportunity for the put buyer to take over 100% profits on the position.

At expiration, the stock was trading for $100, and the 98 put expired worthless. If the put buyer didn’t take profits in one of the profitable periods, the trader would have realized the maximum loss of $149.

In the final example, we’ll look at a situation where a trader buys a deep-in-the-money put option.

Trade Example #3: Buying an In-the-Money Put Option

In this final example, we’ll look at the performance of a deep-in-the-money put option. When purchasing a deep-in-the-money option, most of the option’s value is intrinsic, which is not subject to losses from time decay or decreases in implied volatility. However, the loss potential is more significant than at-the-money or out-of-the-money options due to the larger premium paid.

Here are the trade details:

Initial Stock Price: $254.51

Put Strike and Expiration: 300 put expiring in 63 days

Put Purchase Price: $52.70

Put Breakeven Price: $300 strike price – $52.70 debit paid = $247.30

Maximum Profit Potential: $247.30 x 100 = $24,730 (stock price goes to $0)

Maximum Loss Potential: $52.70 put purchase price x 100 = $5,270

Let’s see how this put performs over time:

Long Put #3 Trade Results

As we can see in this example, the long 300 put was profitable the entire period because the stock price was below the put’s breakeven price. Additionally, in-the-money options are less exposed to time decay and decreases in implied volatility because most of the option’s value is intrinsic.

In this example, the put’s initial delta was -0.75, which represents an expected $75 profit with each $1 decrease in the stock price, which is almost the same as being short 100 shares of stock. In fact, this trader would automatically end up with a short stock position of -100 shares if the 300 put was held through expiration. So, buying in-the-money options is essentially a stock replacement strategy, which explains why the put’s value moves almost one-for-one with the stock in the example above.

Why would a trader purchase an in-the-money put as opposed to shorting shares of stock? Well, even though the loss potential when buying an in-the-money put is significant ($5,270 in this case), the position still has less risk than shorting shares of stock. Consequently, the margin requirement for buying an option may also be significantly less than shorting stock.

Final Word

In conclusion, we have learned:

Long puts are generally unprofitable because of the effects of time decay.
If the underlying stays the same or goes up in value, long puts will lose money.
For very bearish traders with small accounts, buying a put could be a nice alternative to selling stock.

Next Lesson

Additional Resources

Long Put – The Options Industry Council

Synthetic Long Stock Strategy (Guide w/ Examples)

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 01:53 pm

The synthetic long stock position consists of simultaneously buying a call option and selling the same number of put options at the same strike price. Both options must be in the same expiration cycle. As the strategy’s name suggests, a synthetic long stock position replicates buying and holding 100 shares of stock.

By owning a call option and selling a put option at the same strike price, the position’s delta exposure will be +100. Compared to buying shares of stock, a trader may be able to enter a synthetic long stock position with a lower margin requirement than buying shares.

TAKEAWAYS

The synthetic long stock trade is an advanced options trading strategy.
The position is created from buying a call option and selling a put option of the same strike.
The position is suited for very bullish investors who don’t want to pay for the stock.
Due to the short put, max loss in this strategy is great.

Synthetic Long Stock - Strategy Characteristics

Let’s go over the strategy’s general characteristics:

Max Profit Potential: Unlimited

Max Loss Potential:

If the synthetic is entered for a debit: (Strike Price + Debit) x 100

If the synthetic is entered for a credit: (Strike Price – Credit) x 100

Expiration Breakeven:

If the synthetic is entered for a debit: Strike Price + Debit Paid

If the synthetic is entered for a credit: Strike Price – Credit Received

Estimated Probability of Profit: Approximately 50% because a synthetic long stock replicates owning shares of stock.

To demonstrate these characteristics in action, let’s take a look at a basic example.

Profit/Loss Potential at Expiration

In the following example, we’ll replicate a long share position from the following option chain:

In this example, we’ll simultaneously buy the 100 call and sell the 100 put. When trading synthetic stock positions, you can use any strike price because the breakeven of each position will be the same. We choose to use the at-the-money options because they are the most actively traded options, which benefits traders in terms of liquidity. Lastly, let’s assume the stock price is trading for $100 when entering the position:

Initial Stock Price: $100

Synthetic Long Stock Setup: Long 100 call for $3.53; Short 100 put for $3.44

Debit Paid for Synthetic: $3.53 paid – $3.44 collected = $0.09

Breakeven Price: $100 strike price + $0.09 debit paid = $100.09

As you can see, the position’s breakeven is only $0.09 above the current stock price. The difference is explained by carrying costs that are priced into the options. In this example, the carrying costs stem from the risk-free interest rate, as the stock in this example does not pay any dividends.

The following visual describes the position’s potential profits and losses at expiration:

As we can see here, the risk profile of a synthetic long stock position is identical to an actual long stock position. The only difference is the breakeven price, which is miniscule. To be profitable when trading synthetic long stock positions, the stock price must increase from the point of entry.

Nice job! You’ve learned the general characteristics of the synthetic long stock position. Now, let’s go through a real trade example and visualize the performance of the position through time.

Synthetic Long Stock Trade Example

To bring the previous section to life, we’re going to look at a real synthetic long stock example and visualize the position’s performance over time. Here’s the trade setup:

Initial Stock Price: $109.82

Strikes and Expiration: Long 110 call for $4.13; Short 110 put for $4.28; Both options expiring in 45 days

Net Credit: $4.28 in premium collected – $4.13 in premium paid = $0.15 net credit

Breakeven Price: $110 strike price – $0.15 net credit = $109.85

Maximum Profit Potential: Unlimited

Maximum Loss Potential: $109.85 x 100 = $10,985

Let’s see what happens!

As you can see, the performance of a long stock position and synthetic long stock position are identical. When the stock price increases from the point of entry, both positions are profitable. Conversely, when the stock price falls below the entry price, both positions have losses.

Final Word

Congratulations! You now know how to replicate buying shares of stock with options! Be sure to read the summary of main points below.

This strategy is referred to as “synthetic” because it mirrors a stock position of 100 shares.
For small accounts wanting upside exposure, synthetic calls are a great alternative to buying more expensive stock.
Because of the short, unhedged put, max loss is great for synthetic long positions.

Next Lesson

Additional Resources

Synthetic Long Stock – The Options Industry Council

What is the Collar Spread Strategy? Options Visual Guide

Posted on January 28, 2022April 5, 2022 by Chris Butler

Last updated on April 5th, 2022 , 12:49 pm

The collar spread options strategy consists of simultaneously selling a call option and buying a put option against 100 shares of long stock.

Buying a put option against long shares eliminates the risk of the shares below the put strike, while selling a call option limits the profit potential of shares above the call strike.

By selling a call option, the cost of buying a put option is reduced. When structured properly, the short call can cover the entire cost of buying the put option, resulting in a limited-risk stock position without paying for the insurance.

While the collar spread can be entered for a credit, the true “cost” of implementing the strategy is the elimination of profit potential when the stock price increases significantly. Because of this, some investors prefer to enter into collars only after their long shares have risen significantly.

Let’s first go over the collar’s general characteristics.

TAKEAWAYS

A “collar” consists of buying 100 shares, buying 1 put option and selling 1 call option.
The options in this strategy are all out-of-the-money.
A “cashless” collar exists when the premium sold for the call pays for the long put.
Collars are a great way to hedge long stock, particularly around earnings.

Collar Options Strategy Characteristics

➥ Max Profit Potential:

Collar Credit: [(Short Call Strike – Share Purchase Price) + Credit] x 100

Collar Debit: [(Short Call Strike – Share Purchase Price) – Debit] x 100

➥ Max Loss Potential:

Collar Credit: [(Share Purchase Price – Long Put Strike) – Credit] x 100

Collar Debit: [(Share Purchase Price – Long Put Strike) + Debit] x 100

➥ Expiration Breakeven:

Collar Credit: Share Purchase Price – Credit

Collar Debit: Share Purchase Price + Debit

To demonstrate how a collar is used in practice, we’ll need to run through two examples.

Collar Expiration P/L Example #1

In the first example, we’ll construct a collar from the following option chain:

In this case, we’ll sell the 155 call and buy the 145 put. Let’s assume 100 shares of stock were purchased for $150 per share.

Initial Share Purchase Price: $150

Options Used: Long 145 Put for $5.00; Short 155 Call for $5.66

Credit Received: $5.66 received – $5.00 paid = $0.66

Breakeven Price: $150 share purchase price – $0.66 collar credit = $149.34

The following visual describes the position’s potential profits and losses at expiration:

Collar Trade Outcomes

As we can see here, the small credit from the collar results in a breakeven price lower than the purchase price of the shares.

The scenarios below explains the performance of this collar position based on various stock prices at expiration:

➥Stock Price Below the Long Put Strike ($145)

The long 145 put locks in the losses of the long shares, resulting in the maximum loss potential for the position.

➥Stock Price at the Breakeven Price ($149.34)

The short call and long put expire worthless, resulting in a profit of $66 based on the $0.66 credit. However, the long shares have losses equal to $66, so the position breaks even overall.

➥Stock Price at the Share Purchase Price ($150)

The long shares have no profits or losses, but the collar expires worthless and the trader keeps the $0.66 credit. The overall profit in this case is $66.

➥Stock Price Above the Short Call Strike ($155)

The profit potential of the long shares is capped because the short call represents an obligation to sell shares at the strike price. At any price higher than the short call strike price, the investor realizes maximum profit.

Collar Expiration P/L Example #2

In the next example, we’ll construct a collar from the same option chain as before:

Just like before, we’ll sell the 155 call and buy the 145 put. However, let’s assume that 100 shares of stock were purchased for $130 per share a few months ago.

Initial Share Purchase Price: $130

Options Used: Long 145 Put for $5.00; Short 155 Call for $5.66

Credit Received: $5.66 received – $5.00 paid = $0.66

“Breakeven” Price: $130 share purchase price – $0.66 collar credit = $129.34

As you may notice, we find ourselves in an interesting but favorable situation. The “breakeven” price on this trade is $129.34 because 100 shares of stock were purchased for $130 and $0.66 was just collected from selling the call and buying the put. However, owning the 145 put removes any risk in the long shares below $145. Because of this, there is no loss potential in this position.

The following visual describes the position’s potential profits at expiration:

Collar Trade Outcomes

As we can see here, there is no loss potential for this position because the collar was entered after a significant increase in the stock price and the put strike of the collar is above the share purchase price.

The minimum profit potential in this case is equal to: [($145 Long Put Strike – $130 Share Purchase Price) + $0.66 Credit] x 100 = +$1,566.

The maximum profit potential is equal to: [($155 Short Call Strike – $130 Share Purchase Price) + $0.66 Credit] x 100 = +$2,566.

Nice job! You’ve learned the general characteristics of the collar strategy. Now, let’s go through some visual trade examples to see how a collar performs through time.

Collar Example Trades

In the following examples, note that we don’t specify the underlying, since the same concepts apply to collars on any stock. Additionally, each example demonstrates the performance of a single collar position. When trading more contracts, the profits and losses in each case are magnified by the number of collars traded.

Let’s do it!

Maximum Profit - Collar Trade Example #1

In the following example, we’ll investigate a situation where the stock price rises continuosly and is above the collar’s short call strike at expiration. Here’s the setup:

Initial Stock Price: $552.94

Strikes and Expiration: Long 495 put; Short 595 call; Both options expiring in 52 days

Premium Collected for Call: $10.67

Premium Paid for Put: $8.42

Net Credit: $10.67 in premium collected – $8.42 in premium paid = $2.25 net credit

Breakeven Price: $552.94 share purchase price – $2.25 collar credit = $550.69

Maximum Profit Potential:

[($595 short call strike – $552.94 share purchase price) + $2.25 collar credit] x 100 = $4,431

Maximum Loss Potential:

[($552.94 share purchase price – $495 long put strike) – $2.25 collar credit] x 100 = $5,569

Let’s take a look:

Collar #1 Trade Results

As we can see here, the stock price rallied from $552.94 to $625, resulting in significant profits on the long shares. However, the collar position’s profits are capped because the short call limits the profit potential on the long shares. In this example, the maximum profit potential is $4,431, which is the exact profit at expiration.

At expiration, the trader would be assigned -100 shares of stock at the short call’s strike price of $595. As a result, the trader would be left with no position. If the trader wanted to keep the shares, they would have to buy back the short call for a loss before expiration. However, keep in mind that early assignment is always possible when the short call is in-the-money before expiration.

Maximum Loss - Collar Trade Example #2

In the second example, we’ll examine how a collar position reduces the loss potential of a long stock investment. Here’s the setup:

➥ Initial Stock Price: $223.41

➥ Strikes and Expiration: Long 195 put; Short 245 call; Both options expiring in 46 days

➥ Premium Collected for Call:$6.70

➥ Premium Paid for Put: $5.43

➥ Net Credit: $6.70 in premium collected – $5.43 in premium paid = $1.27 net credit

➥ Breakeven Price: $223.41 share purchase price – $1.27 collar credit = $222.14

➥ Maximum Profit Potential:

[($245 short call strike – $223.41 share purchase price) + $1.27 collar credit] x 100 = $2,286

➥ Maximum Loss Potential:

[($223.41 share purchase price – $195 long put strike) – $1.27 collar credit] x 100 = $2,714

Let’s see what happens!

Collar #2 Trade Results

In this example, we can see that the stock price collapses from $222 to $145, resulting in huge losses for the long stock position. However, the collar position is protected because the long put gains value as the stock price decreases, which offsets losses on the long shares. Additionally, the short call loses value as the stock price decreases, which also offsets the losses on the long shares.

Compared to the long stock position, the collar in this example only loses $2,714, while the long stock position is down $8,000 at the lowest point.

At expiration, the long put would automatically be exercised and the trader would effectively sell 100 shares of stock at the put’s strike price of $195. If the trader wanted to keep their shares, they could just sell the long put for a profit before expiration.

Entering a Collar to Protect Share Profits - Trade Example #3

In the final example, we’ll examine how a collar position can be used to protect the profits on a long share position. Here’s the setup:

➥ Initial Share Purchase Price:$151.04

➥ Share Price When Entering Collar: $265.42

➥ Strikes and Expiration: Long 245 put; Short 280 call; Both options expiring in 44 days

➥ Premium Collected for Call: $12.30

➥ Premium Paid for Put:$12.05

➥Net Credit: $12.30 in premium collected – $12.05 in premium paid = $0.25 net credit

➥ Breakeven Price: $151.04 share purchase price – $0.25 collar credit = $150.79

➥ Maximum Profit Potential:

[($280 short call strike – $151.04 share purchase price) + $0.25 collar credit] x 100 = +$12,921

➥ Maximum Loss Potential:*

[($245 long put strike – $151.04 share purchase price) + $0.25 collar credit] x 100 = +$9,421

*In this example, we’ve altered the maximum loss calculation to result in a positive number because this particular position has no loss potential. Using the standard formula from the other examples would give us a negative maximum loss number, which represents a profit. Adjusting the formula was done to avoid confusion.

As we can see from the table above, there is no loss potential on this position because the share purchase price is well below the long put strike. Let’s see what happens over time:

Collar #3 Trade Results

As we can see from this scenario, the stock price did end up falling after the collar was entered. With the stock price below the long 245 put at expiration, the overall profit on the collar position was +$9,421 like we calculated previously. Meanwhile, the profit on the long stock position without the collar was +$7,500. The outperformance of the collar stems from the profits on both the long 245 put and short 280 call.

The example above demonstrates how collars are most commonly used in practice.

Final Word

Congratulations! You’ve learned the basics of how the collar strategy works, and how it’s commonly used in practice. In a nutshell:

Collars provide great downside protection in volatile markets.
Over the long run, outright stock tends to outperform collar trades.
If the premium collected from the call is equal to or greater than the premium paid for the put, the collar is said to be “cashless”.

Next Lesson

Additional Resources

Collar Protective Collar – The Options Industry Council (OIC)

Protective Put Options Strategy – Guide W/ Visuals

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 02:02 pm

The protective put options strategy (also known as a “married put”) consists of buying a put option against 100 shares of long stock.

As the name suggests, a protective put is a defensive strategy that reduces the risk of owning shares of stock.

When a put is purchased against 100 shares of stock, the risk of those shares is eliminated below the strike price of the put option. The risk reduction comes at the cost of increasing the breakeven price on the shares, as the shares must increase by the cost of the put option for the strategy to break even at the expiration date of the put option.

TAKEAWAYS

The protective put consists of 1.) purchasing 100 shares of stock and 2.) purchasing one put option.
Protective puts allow investors to sell their long stock at the puts strike price.
Protective puts are great for bullish yet jittery markets.
Max loss on the protective put is the current stock price minus the strike price
Max profit on a protective put is uncapped.

Protective Put Options Strategy Characteristics

Let’s go over the strategy’s general characteristics:

○Max Profit Potential: Unlimited

○Max Loss Potential: [(Stock Purchase Price – Put Strike Price) + Debit Paid for Put] x 100

○Expiration Breakeven: Stock Purchase Price + Debit Paid for Put

○Estimated Probability of Profit:

Less than 50% because the price paid for the put increases the effective purchase price of the shares.

To demonstrate these characteristics in action, let’s take a look at a basic example.

Protective Put: Profits/Losses at Expiration

In the following example, we’ll construct a protective put from the following option chain:

In this case, we’ll buy the 145 put for $5.00. Let’s also assume 100 shares of stock were purchased for $150 per share.

Initial Stock Purchase Price: $150

Long Put Strike Used: $145 Put

Debit Paid for Put: $5.00

Breakeven Price: $150 share purchase price + $5.00 put price = $155

Maximum Profit Potential: Unlimited

Maximum Loss Potential: $1,000 [(150 Stock Purchase Price – 145 Put Strike) + $5.00 Paid for Put] x $100

The following visual describes the position’s potential profits and losses at expiration:

Protective Put Trade Results

As we can see here, the position will be unprofitable at any stock price below $155. Since the shares were purchased at $150, this means the stock price must rise $5 before any profits occur at expiration. Because of this, the probability of making money on this trade is less than 50%, in theory. However, the risk of the shares has been eliminated below $145, which is the strike price of the protective put.

Below explains the performance of this position based on various scenarios at expiration:

Protective Put at Different Expirations

○Stock Price Below the Long Put Strike ($145)

The value of the 145 put offsets the losses on the long shares, capping the maximum loss potential to $1,000. For example, at $130, the 145 put will be worth $15 at expiration, resulting in a $1,000 profit on the long put. The long shares will have a loss of $2,000 since they were purchased at $150. Consequently, the net loss is $1,000.

○Stock Price Between the Long Put Strike ($145) and the Stock Purchase Price ($150)

The long 145 put expires worthless ($500 loss), and the long shares are unprofitable. The loss is therefore between -$500 and -$1,000.

○Stock Price Between the Share Purchase Price ($150) and the Breakeven Price ($155)

The long shares are profitable, but not more than the $5 premium that was paid for the 145 put. Overall, the position is not profitable.

○Stock Price Above the Breakeven Price ($155)

The profit on the long shares exceeds the $5 in premium that was paid for the 145 put. As a result, the position is profitable. The exact profits are equal to: (Stock Price – $155) x 100.

Great job! You’ve learned the general characteristics of the protective put strategy. Now, let’s go through some visual trade examples to understand the strategy’s performance through time.

Married Put (Protective Put) Trade Examples

In the following examples, note that we don’t specify the underlying because the same concepts apply to protective puts on any stock. Additionally, each example demonstrates the performance of a single married put position. When trading more contracts, the profits and losses in each case are magnified by the number of protective puts traded.

Let’s do it!

Profitable Protective Put - Trade Example #1

The first example we’ll look at is a scenario where a hypothetical trader makes a small profit after entering a protective put.

Share Purchase Price: $77.21

Put Strike and Expiration: Long 77.5 put expiring in 74 days

Premium Paid for Put: $4.95

Breakeven Price (Effective Share Cost):

$77.21 share purchase price + $4.95 put purchase price = $82.16

Maximum Profit Potential:

Unlimited

Maximum Loss Potential:

[($77.21 share purchase price – $77.5 put strike) + $4.95 premium paid for put] x 100 = $466

Let’s see what happens!

Protective Put #1 Trade Results

In the top half of the chart, we can see the stock price over time, as well as the long put strike and the position’s breakeven price. In the bottom half of the chart, we can see the performance of a married put’s components (the green line represents the combined performance of the components).

The above example demonstrates how purchasing a put against shares of stock reduces the overal profits on the long stock position. In this case, the married put position performs $495 worse than the long stock position, which is the cost of the 77.5 put.

Reducing Risk With a Protective Put - Trade Example #2

In the following example, we’ll investigate a situation where the stock price collapses after a hypothetical trader enters into a married put position. Here’s the setup:

Share Purchase Price: $254.53

Put Strike and Expiration: Long 245 put expiring in 37 days

Premium Paid for Put: $14.15

Breakeven Price (Effective Share Cost):

$254.53 share purchase price + $14.15 put purchase price = $268.68

Maximum Profit Potential:

Unlimited

Maximum Loss Potential:

[($254.53 share purchase price – $245 put strike) + $14.15 premium paid for put] x 100 = $2,368

Let’s take a look at the trade performance:

Protective Put #2 Trade Results

In this example, we can see that the stock price collapses from $254.53 to nearly $200 in a short period of time. Consequently, the long stock position suffers significant losses. However, the protective put position outperforms because the long put gains value as the stock price decreases. Additionally, we can see that the position’s losses are capped at $2,368, which is the maximum loss potential of this particular trade.

At expiration, the long put would expire to -100 shares of stock. Since the protective put trader already owns 100 shares of stock, the positions would offset and the trader would be left with no shares.

Final Word

Congratulations! You now know how selling the protective put options strategy works! Be sure to read the recap of main points below!

Combining stock with a long put is known both as a “protective put” and a “married put”.
Time decay works against the long put.
A rise in implied volatility increases the value of all options.
Because of the long stock, the upside in this strategy is capped, but this is lessened by the amount of premium paid for the put .

Next Lesson

Additional Resoures

Protective Put Married Put – The Options Industry Council

How the Covered Strangle Option Strategy Works (Guide W/ Visuals)

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 02:04 pm

The covered strangle strategy is a bullish strategy that consists of simultaneously buying 100 shares of stock while also selling a strangle. The strangle is “covered” because the long shares “cover” the risk of the short call. A normal short strangle position has unlimited upside risk, but when 100 shares are purchased, the upside risk of the strangle is eliminated.

A covered strangle position can be conceptualized in two ways:

1) Simultaneously selling a strangle and buying 100 shares of stock

2) Simultaneously buying a covered call (+100 shares, -1 call option) and selling a put

Since the covered strangle combines a covered call and a short put into one position, it is a strategy that can be used when an investor wants to sell their shares at a higher price, but would also be willing to buy more shares if the stock price falls.

TAKEAWAYS

A covered strangle is created by 1. owning 100 shares of stock 2. selling 1 out-of-the-money call 3. selling 1 out-of-the-money put.
Both options sold must be of the same expiration cycle.
Max profit potential for this trade is limited to the total credit received plus upper strike price minus stock price.
Max loss is great for the covered strangle, as a declining market will hit both the long stock and the short put.

Covered Strangle Trade Characteristics

Let’s go over the strategy’s general characteristics:

Max Profit Potential:

[(Call Strike Price – Stock Purchase Price) + Premium Received for Strangle] x 100

Max Loss Potential:

[(Short Put Strike Price – Strangle Credit) + Share Purchase Price] x 100

Breakeven Price at Expiration:

Stock Purchase Price – Premium Received for Strangle

To demonstrate these characteristics in action, let’s take a look at a basic example.

Covered Strangle Profit/Loss Potential at Expiration

In the following example, we’ll construct a covered strangle from the following option chain:

In this case, we’ll sell the 210 call and 190 put for a total credit of $8.09. Let’s also assume the stock price is trading for $200 when we put this trade on:

Initial Stock Purchase Price: $200

Strangle Strikes: $190 short put, $210 short call

Credit Received for Strangle: $8.09

Covered Strangle Breakeven: $200 share price – $8.09 strangle credit = $191.91

The following visual describes the position’s potential profits and losses at expiration:

Covered Strangle Trade Results

As we can see here, the covered strangle profits when the stock price is above the breakeven price. In other words, the strategy profits when the losses on the shares do not exceed the premium collected for selling the strangle.

Additionally, we can see that the profit potential is capped at any stock price above the short call strike. Lastly, you may notice the losses accelerate when the stock price is below the short put strike. At expiration, an in-the-money short put has a delta of +100. Since a covered strangle trader already owns 100 shares, their net position delta will be +200 if the stock price is below the short put strike price.

Great job! You’ve learned the general characteristics of the covered strangle strategy. Now, let’s go through some visual trade examples to see how the strategy performs through time.

Covered Strangle Trade Examples

In each example, note that we don’t specify the underlying, since the same concepts apply to covered strangles on any stock. Additionally, each example demonstrates the performance of a single covered strangle position. When trading more contracts, the profits and losses in each case are magnified by the number of covered strangles traded.

Let’s do it!

Small Covered Strangle Profits - Trade Example #1

The first example we’ll look at is a scenario where the stock price remains relatively flat after a hypothetical trader enters a covered strangle.

Initial Share Purchase Price: $212.44

Strangle Strikes and Expiration: Short 219 Call; Short 201 Put; Both options expiring in 63 days

Premium Collected for Strangle: $1.75 for the call + $0.83 for the put = $2.58

Breakeven Price: $212.44 share purchase price – $2.58 strangle credit = $209.86

Maximum Profit Potential: ($219 short call strike – $209.86 breakeven) x 100 = $914

Maximum Loss Potential: [(201 Short Put – $2.58) + $212.44 Share Purchase Price] x 100 = $41,086 (stock price at $0)

Let’s see what happens!

Covered Strangle #1 Trade Results

In the top half of the chart, you can see the stock price, short put and call strikes, and the covered strangle’s breakeven price. In this example, the stock price was relatively flat and was only a few points higher than the breakeven price at expiration.

In the bottom half of the chart, we can see the P/L performance of the covered strangle components (the green line represents the combined performance of the long shares and short strangle). In this example, the short strangle decayed steadily over time, and expired worthless at expiration. The long stock position ended up not making any money because the stock price was around $212.44 at expiration. However, the covered strangle made money overall because of the profits from the short strangle.

At expiration, this trader would not have to take any action to avoid assignment on the short options because the options are out-of-the-money. Additionally, this covered strangle trader would be able to sell another strangle in the next expiration cycle to collect more credit against their stock position.

Ok, so you’ve seen a slightly profitable covered strangle that breaks even. Next, we’ll look at a scenario where a covered strangle position realizes the maximum profit potential at expiration.

Maximum Profit Covered Strangle - Trade Example #2

In the following example, we’ll investigate a situation where the stock price rises continuosly after a hypothetical trader enters a covered strangle.

Here’s the setup:

Initial Share Purchase Price: $82.09

Strangle Strikes and Expiration: Short 95 Call; Short 67.5 Put; Both options expiring in 88 days

Premium Collected for Strangle: $2.54 for the call + $3.05 for the put = $5.59

Breakeven Price: $82.09 share purchase price – $5.59 strangle credit = $76.50

Maximum Profit Potential: ($95 short call strike – $76.50) x 100 = $1,850

Maximum Loss Potential: [(67.5 Short Put Strike – $5.59 Strangle Credit) + $82.09 Stock Purchase Price] x 100 = $14,400 (stock price at $0)

Let’s take a look:

Covered Strangle #2 Trade Results

In this example, we can see that the stock price surges from $82.09 to nearly $110 over the 88-day period the covered strangle was on. As a result, the long stock portion of the trade performed well, but the short strangle actually lost money. As a result, the long stock position performed the best, but the covered strangle wasn’t far behind.

At expiration, the short call would expire to -100 shares, which means the covered strangle trader would lose their long stock. If the trader wanted to keep their shares, the short call would need to be purchased back before expiration. However, it’s still possible that the trader is assigned early on the short call, so there’s no guarantee that the trader in this example would keep their shares.

Covered Strangle Gone Wrong - Trade Example #3

In the final example, we’ll look at a covered strangle trade that suffers significant losses due to a decrease in the stock price. Here’s the setup:

Initial Share Purchase Price: $636.98

Strangle Strikes and Expiration: Short 725 Call; Short 570 Put; Both options expiring in 74 days

Premium Collected for Strangle: $19.60 for the call + $13.92 for the put = $33.52

Breakeven Price: $636.98 share purchase price – $33.52 strangle credit = $603.46

Maximum Profit Potential: ($725 short call strike – $603.46) x 100 = $12,154

Maximum Loss Potential: [(570 Short Put Strike – $33.52 Strangle Credit) + $636.98 Share Purchase Price] x 100 = $117,346 (stock price at $0)

Let’s see what happens!

Covered Strangle #3 Trade Results

As we can see here, the stock price fell from $636.98 to below $500 in a very short period. Consequently, the covered strangle performed poorly because the strategy includes long stock and a short put, which are both bullish components. Later on in the period, the covered strangle ended up outperforming the long stock position because the short strangle ended up being profitable.

At expiration, this covered strangle trader would be assigned +100 shares of stock from the 570 put. If the trader wanted to avoid assignment, they would need to buy back the short put before expiration. However, keep in mind that the put was deep-in-the-money before expiration, so there’s always a possibility that the trader gets assigned early.

Final Word

Congratulations! You now know how the covered strangle works as a trading strategy!

Perhaps the most important thing to take away from this strategy is the great downside risk – you have both stock AND short put exposure should the underlying plummet.

Next Lesson

Additional Resources

Covered Strangle Covered Combination – The Options Education Organization

Covered Call Options Strategy: Complete Guide w/ Visuals

Posted on January 28, 2022March 22, 2022 by Chris Butler

Last updated on March 22nd, 2022 , 11:41 am

Covered call writing is an options trading strategy that consists of selling a call option while owning at least 100 shares of the stock. On a perfect 1:1 ratio, one call option can be sold for every 100 shares of stock that are owned.

By itself, selling a call option is a highly risky strategy with unlimited loss potential. However, when combined with a long stock position of 100 shares, selling a call option adds no additional risk, and creates a way to profit when the share price remains flat or even declines slightly.

Even more, the credit received for the call option provides downside protection against decreases in the stock price. The cost of this protection is that the long stock position’s potential profits are limited by selling the call.

In this post, you will learn the covered call strategy through in-depth examples and visualizations with real option data.

For those with smaller trading accounts, the poor man’s covered call is an alternative to covered calls that requires significantly less money to trade.

TAKEAWAYS

The covered call is an income generation strategy for equity owners who do not anticipate their stock will go higher in the future.
In order for the position to be “covered”, 100 shares of stock must be long for every call that is sold.
Most traders prefer selling “out-of-the-money” calls as these have a higher probability of expiring worthless.
Covered calls can be profitable in bearish, neutral, and even slightly bullish markets.
Maximum loss is high on this trade, as the stock still has downside risk.

Covered Call Writing - Strategy Characteristics

Let’s go over the strategy’s general characteristics:

➥Max Profit Potential: (Short Call Strike + Credit Received for Call – Share Purchase Price) x 100

➥Max Loss Potential: (Share Purchase Price – Credit Received for Call) x 100

➥Expiration Breakeven: Share Purchase Price – Credit Received for Call

➥Approximate Probability of Profit: Greater than 50%

To gain a better understanding of these concepts, let’s walk through a basic example.

Profit/Loss Potential at Expiration

In the following example, we’ll construct a covered call position from the following option chain:

Trade Details

In this case, let’s assume the stock price is trading for $75 at the time of these option quotes. To construct a covered call, we’ll first buy 100 shares of stock at $75 per share. Next, we’ll sell one of the call options from above. For this example, we’ll sell the 80 call.

Share Purchase Price: $75

Short Call Strike Sold: $80

Premium Collected for the 80 Call: $3.00

Here are this particular position’s characteristics:

Max Profit Potential:

($80 short strike + $3 credit received – $75 share purchase price) x 100 = $800

Max Loss Potential:

($75 share purchase price – $3 credit received) x 100 = $7,200 (stock price goes to $0)

Expiration Breakeven Price (Effective Share Purchase Price):

$75 share purchase price – $3 credit received = $72

Probability of Profit: Greater than 50%

Position if Assigned:

If assigned on the short 80 call, then the covered call writer is obligated to sell 100 shares of stock at the strike price. Since the trader already owns 100 shares, the assignment leaves the trader with no position. However, the bright side is that a being assigned results in maximum profit for the covered call writer.

The following visual demonstrates the potential profits and losses for this particular position at expiration:

Covered Call Outcomes

As you can see, buying 100 shares of stock at $75 and selling the 80 call for $3 reduces the risk of the position compared to just buying and holding stock. Since a credit is collected for selling the call, the purchase price of the shares is effectively reduced by the amount of the call price. Therefore, the breakeven price of a covered call position is essentially the reduced purchase price of the shares. However, for this purchase price reduction, the position’s potential profits are capped when the stock price rises above the strike price of the short call.

We’ve also added the profits and losses for a long stock position as a comparison. Compared to the long stock position, the covered call has less loss potential and more profit potential at most of the prices. However, if the stock price rises significantly above the short call strike, then the long stock position without a short call against it performs better. Because of this, a covered call writer is usually not extremely bullish on the stock.

Great job! You know the potential outcomes of a covered call position at expiration, but what about before expiration? As a demonstration, we’re going to look at a few positions that recently traded in the market.

Covered Call Trade Examples

In the following examples, we’ll compare changes in the stock price to a covered call position on that stock. Note that we won’t discuss the specific stock the trade was on, as the same concepts apply to each stock.

Covered Call vs. Holding Shares - Trade Example #1

First, let’s examine a situation where covered call writing is less lucrative than just buying and holding shares of stock. Here’s the setup:

Initial Share Purchase Price: $121.45

Strike Price and Expiration: Short 125 call expiring in 74 days

125 Call Sale Price: $1.41

Breakeven Stock Price (Effective Share Purchase Price):

$121.45 share purchase price – $1.41 credit received from call = $120.04

Maximum Profit Potential:

($125 short call strike – $120.04 effective share purchase price) x 100 = $496

Maximum Loss Potential:

$120.04 effective share purchase price x 100 = $12,004 (stock price goes to $0)

Purchasing 100 shares of stock for $121.45 per share and selling one of the 125 calls for $1.41 results in a breakeven price of $120.04. Because of this, the stock price can fall, and the covered call can still profit. However, for that protection, the profit on the long shares is capped. At expiration, any stock price above the short call strike of $125 will result in the same gain for the covered call writer.

With that said, let’s see what happens!

Covered Call #1 Trade Results

As illustrated here, the stock price rising above $132.50 results in profits of $1,250 for an investor who just bought and held 100 shares of stock.

On the other hand, the profit potential is limited for an investor who sold the 125 call against their shares. It doesn’t matter if the stock price is $125 or $1,000 at expiration, the profit on a covered call position with a short 125 call will be the same.

So, by selling a call against shares of stock, an investor gains the ability to profit when the stock stays flat or declines slightly. However, that benefit comes at the cost of profit potential on the long shares.

In this example, the maximum profit potential is achieved fairly early in the trade because the stock price traded significantly higher than the short call strike price. When maximum profit is achieved before expiration, it’s likely that the trader will close the position to lock in the profits. To close a covered call position, the trader can simultaneously sell the shares of stock and buy back the short call.

After expiration, this particular covered call writer would lose their shares if they held the short 125 call through expiration. To keep the shares, the investor would have to buy back the 125 short call at a loss, though the overall covered call position was profitable. Lastly, it’s important to note that the trader in this scenario faces an early assignment on the short call because the option is deep-in-the-money for most of the trade.

Next, we’ll look at an example of when covered call writing works out perfectly.

Income-Generating Covered Call - Trade Example #2

In the next example, we’ll look at a situation where the stock price remains in a particular range over 53 days. More specifically, the stock price is the same at the beginning and the end of the period. Over this time frame, we’ll compare a covered call position to a long stock position.

Here’s the setup:

Initial Share Purchase Price: $116.45

Strikes and Expiration: Short 120 call expiring in 53 days

120 Call Sale Price: $5.80

Breakeven Stock Price (Effective Share Purchase Price):

$116.45 share purchase price – $5.80 credit received from call = $110.65

Maximum Profit Potential:

($120 short call strike – $110.65 effective share purchase price) x 100 = $935

Maximum Loss Potential:

$110.65 effective share purchase price x 100 = $11,065 (stock price goes to $0)

This time around, we’re examining a covered call position where 100 shares of stock are purchased for $116.45 per share, and the 120 call is sold for $5.80. The breakeven price in this case is $110.65, which means the stock can fall $5.80 and the covered call writer will not lose money.

Let’s take a look at what happens:

Covered Call #2 Trade Results

The first thing to note about this trade is that the covered call position performs better than a long stock position when the shares remain below the short call’s strike price. This is because the profits from the short call offset losses (or add profits) when the stock price is below the short call’s strike price.

The second thing to note is that after expiration, this particular covered call writer would keep all the premium from selling the call, as the 120 call expires worthless. Since the 120 call was sold for $5.80, the covered call writer realizes a $580 profit when the call expires worthless (out-of-the-money). Additionally, when the short call expires out-of-the-money, a covered call writer keeps their long shares.

Lastly, you’ll notice that the long stock investor broke even on their position, as the stock price was the same at the beginning and the end of the period. However, the covered call writer made $580 from the premium collected on the call option. So, selling calls against long stock can be highly lucrative in a period of range-bound stock prices.

In the final example, we’ll look at a covered call position that is defensive in nature. While not profitable, we’ll see how the covered call compares to a long stock position.

A Defensive Covered Call - Trade Example #3

As mentioned throughout this guide, covered call writing provides protection against declines in the stock price. Because of this, covered calls can be used defensively. So, in the final example, we’ll look at a scenario where a covered call position is unprofitable but better off than just buying and holding stock.

Here are the specifics of the final example:

Initial Share Purchase Price: $119.99

Strikes and Expiration: Short 120 call expiring in 37 days

120 Call Sale Price: $2.58

Breakeven Stock Price (Effective Share Purchase Price):

$119.99 share purchase price – $2.58 credit received from call = $117.41

Maximum Profit Potential:

($120 short call strike – $117.41 effective share purchase price) x 100 = $259

Maximum Loss Potential:

$117.41 effective share purchase price x 100 = $11,741 (stock price goes to $0)

Let’s see what happens!

Covered Call #3 Trade Results

In this particular trade, the stock price fell sharply, resulting in losses for the covered call writer and the long stock investor. However, since the covered call writer collected $2.58 in premium, their loss was $258 less than the long stock investor at the expiration of the short call, demonstrating how a covered call can be used defensively.

Congratulations! You now know how the covered call strategy works! In the next section, we’ll discuss how to select which call to sell.

How to Select a Covered Call Strike Price

At this point, you know how covered calls work, as well as when you might use the strategy. However, with so many different call strikes available, how do you choose which one to sell? We’ve put together a simple guide that may help the strike price selection process easier.

Strike Price Selection: Determine Your Stock Price Outlook

Before selecting a call strike to sell, it’s crucial to determine an outlook for the shares of stock that you own. Here is a quick guide that demonstrates how to select a call strike based on various outlooks:

You Believe the Share Price Will Increase Significantly:

With such a bullish outlook, selling calls to limit the profit potential on the long shares might not make sense. Additionally, selling far-out-of-the-money calls doesn’t provide much profit potential or downside protection since far-out-of-the-money options are cheap.

You Believe the Share Price Will Increase Moderately:

Selling a call option with a delta between 0.20 – 0.30 may be logical, as those options only have a 20-30% probability of being in-the-money at expiration (in theory).

You Believe the Share Price Will Remain Flat/Decrease Slightly:

With a neutral outlook, selling calls with strike prices closer to the stock price (.40 to .50 delta calls) may be logical. Selling at-the-money calls provides the greatest profit potential from the decay of the call’s extrinsic value.

You Believe the Share Price Will Fall:

With such a bearish outlook, owning shares of stock or trading covered calls is likely not the appropriate strategy.

The table above serves as a guideline for selecting a call to sell. When trading covered calls, there isn’t a “one-size-fits-all” approach. The call that is sold depends on the investor’s outlook for the stock price in the future.

Final Word

Awesome! You’ve reached the end of the guide. Hopefully, you’re much more confident in your understanding of the covered call options strategy.

In a nutshell, we have learned:

Covered calls can help equity owners generate income in sideways markets.
The covered strategy only mildly reduces downside stock risk.
Before determining your strike price, it is important to determine the outlook for a stock.

Next Lesson

Supplemental Reading

Covered Strangle Covered Combination – The Options Education Organization

Bull Put Spread Example W/ Visuals – The Ultimate Guide

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 02:14 pm

A bull put spread is an options strategy that consists of selling a put option while also buying a put option at a lower strike price.

Both options must be in the same expiration cycle. Additionally, each strike should have the same number of contracts (i.e. if selling two puts, two puts at a lower strike should be bought). Selling put spreads is similar to selling naked puts, but far less risky due to buying a put against the short put. As the name suggests, a bull put spread is a bullish strategy, as it tends to profit when the underlying stock price rises.

TAKEAWAYS

Bull put spreads are best suited for bullish traders.
The bull put strategy is comprised of: 1.) buy a put at strike price A 2.) sell a put at strike price B.
The max profit for bull puts is the credit received.
Max loss in this strategy is the difference between strike A and strike B, minus the net premium received.
Breakeven for the bull put is strike B minus the net premium received when selling the spread.

Bull Put Spread Strategy Characteristics

Let’s go over the strategy’s general characteristics:

➥Max Profit Potential: Net Credit Received x 100

➥Max Loss Potential: (Width of Put Strikes – Credit Received) x 100

➥Expiration Breakeven: Short Put Strike – Credit Received

➥Other Known Aliases: Short Put Spread, Put Credit Spread

To gain a better understanding of each concept, let’s walk through a trade example.

Profits/Losses at Expiration for a Bull Put Spread

In the following example, we’ll construct a bull put spread from the following option chain:

Bull Put Construction

To construct a bull put spread, we’ll have to simultaneously sell one of these puts and purchase the same number of puts at a lower strike price. In this case, we’ll sell the 90 put and buy the 85 put. Let’s also assume that the stock price is $90 when selling the spread.

Initial Stock Price: $90

Short Put Strike: $90

Long Put Strike: $85

Premium Collected for the 90 Put: $5.09

Premium Paid for the 85 Put: $2.84

In this example, selling the 90 put for $5.09 and buying the 85 put for $2.84 results in a net credit received of $2.25 (since $5.09 is collected, and $2.84 is paid). Additionally, the “spread width” is the difference between the long and short put strike, which is $5 in this case. Based on a net credit of $2.25 on a $5-wide bull put spread, here are the position’s characteristics:

Max Profit Potential: $2.25 Credit x 100 = $225

Max Loss Potential: ($5-Wide Strikes – $2.25 Credit) x 100 = $275

Expiration Breakeven Price: $90 Short Put Strike – $2.25 Credit = $87.75

Probability of Profit:

This bull put spread example has a probability of profit slightly greater than 50% because the breakeven price is less than the initial stock price, which means the stock price can fall slightly and the position can still profit. Additionally, the maximum loss potential is greater than the maximum profit potential.

Position After Expiration

If the stock price is below 85 at expiration, both puts expire in-the-money. At expiration, an in-the-money long put expires to -100 shares, and an in-the-money short put expires to +100 shares, which nets out to no stock position for the put spread seller. If the stock price is between 90 and 85 at expiration, only the short put expires in-the-money, resulting in a position of +100 shares for the short put spread trader.

The following visual demonstrates the potential profits and losses for this bull put spread at expiration:

Bull Put Trade Results

Stock Price Above the Short Put Strike ($90):

Both the 85 and 90 put expire worthless. The profit on the short 90 put is $509, but the loss on the long 85 put is $284, resulting in a net profit of $225.

Stock Price Between the Short Put Strike ($90) and the Bull Put Spread’s Breakeven Price ($87.75):

The short 90 put expires with intrinsic value, but not more than the $2.25 credit received for the short put spread. Because of this, the bull put spread trader realizes a profit, but not the maximum profit since the position expires with some value.

Stock Price Between the Bull Put Spread’s Breakeven Price ($87.75) and the Long Put Strike ($85):

The short 90 put expires with more intrinsic value than the $2.25 credit the put spread trader collected when selling the spread. Because of this, the trader realizes a loss at expiration, but not the maximum loss.

Stock Price Below the Long Put Strike ($85):

The value of the $5-wide short put spread is $5. Since the spread was sold for $2.25, the trader realizes the maximum loss of $275.

Nice! You know how to determine the potential outcomes of a short put spread at expiration, but what about before expiration? To demonstrate how short put spreads perform before expiration, we’re going to look at a few examples of positions that recently traded in the market.

Bull Put Spread Trade Examples

In the following examples, we’ll compare changes in the stock price to a bull put spread on that stock. Note that we won’t discuss the specific stock the trade was on, as the same concepts regarding short put spreads apply to each stock. Additionally, each example represents one short put spread. The potential gains and losses scales proportionately to the number of put spreads traded.

Trade Example #1: Maximum Loss Bull Put Spread

The first example we’ll investigate is a situation where a trader sells an at-the-money put spread. An at-the-money bull put spread consists of selling an at-the-money put and buying an out-of-the-money put. When constructed properly, the breakeven price is slightly below the current stock price. Here’s the setup:

Initial Stock Price: $109.96

Strikes and Expiration: Short 110 put expiring in 46 days. Long 95 put expiring in 46 days.

Net Credit Received: $9.22 received for the 110 put – $3.67 paid for the 95 put = $5.55.

Breakeven Stock Price: $110 short put strike – $5.55 net credit received = $104.45.

Maximum Profit Potential: $5.55 net credit x 100 = $555.

Maximum Loss Potential: ($15-wide put strikes – $5.55 credit received) x 100 = $945.

Let’s see what happens!

Bull Put #1 Trade Results

As you can see here, the value of the put spread increases as the stock price falls, which is not good for a short put spread trader.

At expiration, both put strikes are in-the-money, which results in the maximum loss of $945 for the short put spread trader: ($5.55 sale price – $15 expiration price) x 100 = -$945. Since a short put expires to +100 shares and a long put expires to -100 shares, no stock position is taken if the trader holds the in-the-money spread through expiration. However, it’s possible that the short put spread trader gets assigned on the short 110 put when it’s in-the-money with little extrinsic value.

Next, we’ll look at an example of a trade where the stock price is below the short put at expiration, but the position is still profitable.

Trade Example #2: Partial Profit

In the next example, we’ll look at a situation where a trader sells an at-the-money put spread and does not realize the maximum profit potential.

Here’s the setup:

Initial Stock Price: $219.28

Strikes and Expiration: Short 220 put expiring in 49 days. Long 190 put expiring in 49 days.

Net Credit Received: $14.60 received for the 220 put – $4.60 paid for the 190 put = $10.

Breakeven Stock Price: $220 short put strike – $10 net credit received = $210.

Maximum Profit Potential: $10 net credit received x 100 = $1,000.

Maximum Loss Potential: ($30-wide put strikes – $10 credit received) x 100 = $2,000.

Let’s take a look:

Bull Put #2 Trade Results

As demonstrated here, the timing of the short put spread entry couldn’t have been worse. With just over 35 days to expiration, the put spread was trading for $20, which represents a $1,000 loss for a trader who sold the spread for $10.

However, since a short put spread has limited loss potential, let’s say the trader in this example held on to the position. Near expiration, the stock price rallied above the short put spread’s breakeven price of $210 and the put spread’s value fell. At expiration, the stock was trading for $217.11, which means the short 220 put was worth $2.89 and the 190 put was worthless. Since the trader sold the spread for $10, the expiration profit on the spread was $711: ($10 sale price – $2.89 expiration price) x 100 = +$711.

Alright, you’ve seen short put spread examples that break even and realize the maximum loss. In the final example, we’ll investigate a trade that winds up with its greatest profit potential.

Trade Example #3: Maximum Profit Put Spread

In the final example, we’ll examine a bull put spread example that ends up with its maximum profit potential.

Here are the specifics of the final example:

Initial Stock Price: $716.03

Strikes and Expiration: Short 700 put expiring in 67 days. Long 640 put expiring in 67 days.

Net Credit Received: $30.20 received for the 700 put – $12.15 paid for the 640 put = $18.05.

Breakeven Stock Price: $700 short put strike – $18.05 net credit received = $681.95.

Maximum Profit Potential: $18.05 net credit received x 100 = $1,805.

Maximum Loss Potential: $60-wide put strikes – 18.05 net credit received = $4,195.

Bull Put Spread #3 Trade Results

When the stock price rises significantly, the value of the put spread falls, which is great news for the put spread seller. In this example, there were plenty of opportunities for the trader to take profits before expiration. To close a bull put spread, the trader can simultaneously buy back the short put and sell the long put. As an example, let’s say the trader wanted to take profits when the spread’s price fell to $10. When the trader buys back the spread for $10, they lock in $805 in profits: ($18.05 initial spread sale price – $10.00 closing price) x 100 = +$805.

At expiration, the stock is trading for over $725, and both the 700 and 640 put expire worthless. The resulting gain on the short 700 put is $3,020 and the loss on the long 640 put is $1,205. Therefore, the net profit on the position is $1,805 for the put spread seller, which is the position’s maximum profit potential.

Final Word

Congratulations! You now know how short put spreads work as a trading strategy. Lastly, let’s go over what we learned:

In the short put spread, a trader wants BOTH options to expire worthless.
This occurs when both the long and short option are out-of-the-money on expiration
Time decay works to the advantage of short puts.

Next Lesson

Additional Resources

Bull Put Spread – Fidelity Investments

Short Put Option Strategy Explained – Guide w/ Visuals

Posted on January 28, 2022March 15, 2022 by Chris Butler

Last updated on March 15th, 2022 , 02:01 pm

Selling put options (sometimes referred to as being “short put options”) is an options trading strategy that consists of selling a put option on a stock that a trader believes will increase in price. The risk in this strategy can be great, so it is important have a solid understanding of this options strategy before placing your first short put trade. Let’s get started!

TAKEAWAYS

Selling puts is a high probability, high risk strategy for neutral to bullish traders.
In the short put, profit is limited to the total credit received.
Max loss in short puts is great and calculated by subtracting the credit received from the strike price.
The short put is ideal for investors who are willing and ready to purchase a stock should it fall to the strike price sold.

Short Put Strategy Characteristics

Let’s go over the strategy’s general characteristics:

•Max Profit Potential: Put Sale Price (Credit Received) x 100

•Max Loss Potential: (Put Strike Price – Credit Received) x 100

•Breakeven Price: Put Strike – Credit Received

To better understand these metrics, let’s go through a simple example.

Profit/Loss Potential at Expiration

In the following example, we’ll construct a short put from the following option chain:

In this case, let’s assume the stock price is $25 when entering the put position. For this trade, we’ll sell the 25 put for $2.00.

Stock Price: $25

Put Strike Price: $25

Put Sale Price: $2.00

The following visual describes the potential profits and losses at expiration for this short put position:

Short Put Trade Results

Stock Price Above the Put’s Strike Price (Above $25)

The put has no intrinsic value, and therefore expires worthless. In this case, the put seller realizes the maximum profit of $200.

Stock Price Between the Breakeven Price and the Put’s Strike Price ($23 to $25)

The put option expires with intrinsic value, but not more than the $2 credit the trader collected when selling the put. Consequently, the short put position is profitable.

Stock Price Below the Put’s Breakeven Price (Below $22)

The put option’s intrinsic value is now greater than the premium the trader collected when selling the put, and therefore the short put position is not profitable.

Stock Price at Zero

The company has gone out of business. Any short put traders will realize the maximum loss potential. For the seller of the 25 put, the loss will be $2,300: ($2 Put Sale Price – $25 Put Expiration Value) x 100 = -$2,300.

Short Puts = High Probability/High Risk

The last thing we’ll point out about this graph is that the breakeven price is below the current stock price. Because of this, selling puts is a high probability strategy. However, this makes sense since the maximum potential loss is greater than the maximum potential reward.

So, you know how the outcomes at expiration when selling puts, but what about before expiration? Understanding how profits and losses occur when selling put options can be explained by the position’s option Greeks (if you want to improve your understanding of the risks of your option positions, read our ultimate guides on the option Greeks).

Nice job! You’ve learned the general characteristics of the put selling strategy. Now, let’s go through some visual examples to solidify your knowledge of how short puts work.

Maximum Profit Short Put - Trade Example #1

To visualize the performance of selling put options, let’s look at a few examples of real puts that recently traded. Note that we don’t specify the underlying, since the same concepts apply to all stocks in the market.

The first example we’ll look at is a situation where a trader sells an at-the-money put option (strike price near the stock price). Here are the specifics:

Initial Stock Price: $147.23

Initial Implied Volatility: 43%

Put Strike and DTE: 150 put expiring in 37 days

Put Sale Price: $8.88

Put Breakeven Price: $150 short put strike – $8.88 credit received = $141.12

Maximum Profit Potential: $8.88 net credit x 100 = $888

Maximum Loss Potential: $141.12 breakeven price x 100 = $14,112 (stock price at $0)

Let’s see what happens!

Short Put Trade Results

As you can see, selling puts is profitable as long as the stock price doesn’t fall quickly and violently. You’ll notice that around 21 days to expiration, the stock price is trading right at the put’s strike price of $150, but the put is worth half of its initial value. Three factors contribute to the put’s price decrease:

1) 15 days have passed, resulting in the decay of the put’s extrinsic value

2) Implied volatility has fallen from 43% to 31% (not visualized by the graph), which indicates a broad decrease in the stock’s option prices.

3) The stock price has risen by $3, which results in lower put prices compared to before. Why? When the stock price increases, put options at every strike price become less valuable because they have a lower probability of expiring in-the-money.

Since short put positions have positive theta, negative vega and positive delta, they profit from the passage of time, decreasing implied volatility, and increasing stock prices. All three of these occurred in this trade example.

Regarding closing this position early, the trader in this example had many opportunities to close the put before expiration to lock in profits. To close a short put, a trader can buy back the put at its current price. As an example, if the trader in this example bought the put back when it was worth $3.00, they would lock in $588 in profits: ($8.88 initial sale price – $3.00 purchase price) x 100 = +$588. If held to expiration, the profit would have been $888 because the put expired worthless.

Next, we’ll look at an example of a short put trade where the stock price is below the put’s strike price at expiration.

Partially Profitable Short Put - Trade Example #2

When the stock price is below a short put’s strike price at expiration, the put seller will not make the full profit potential. However, it is still possible that the trade could work out. To demonstrate this, let’s look at an example where the stock price is trading below the short put’s strike price at expiration.

Here are the specifics:

Initial Stock Price: $673.86

Initial Implied Volatility: 30%

Strike and Expiration: 675 put expiring in 37 days

Put Sale Price: $24.52

Put Breakeven Price: $675 short put strike – $24.52 credit received = $650.48

Maximum Profit Potential: $24.52 credit received x 100 = $2,452

Maximum Loss Potential: $650.48 breakeven price x 100 = $65,048 (stock price at $0)

Let’s take a look at the trade’s performance:

Short Put #2 Trade Results

In this trade, the initial sale price of the 675 put was $24.52, resulting in a breakeven price of $650.48. Initially, the stock price crashed to nearly $640, which is well below the put’s breakeven price. As a result, the price of the 675 put surged to $42, which represents a $1,700 loss for the put seller.

However, the stock regained its losses and was trading around $665 at expiration. With the stock price $10 below the put’s strike price at expiration, the put was worth its intrinsic value of $10. Since the initial sale price was $24.52, the final profit is $1,452 per contract for the put seller: ($24.52 sale price – $10 expiration price) x 100 = +$1,452.

If the put seller let the put expire in-the-money, the resulting position would be +100 shares of stock. Letting an option expire in-the-money is known as “taking assignment.” In the case that the trader doesn’t want a stock position, the short put can be purchased back before expiration. However, keep in mind that it’s always possible to be assigned 100 shares of stock on an in-the-money short put, but unlikely when the put has plenty of extrinsic value.

Alright, you know how well short puts can do. Let’s finish by investigating what can go wrong when selling puts.

Significant Loss from Selling Puts - Trade Example #3

So, what happens when the stock price falls through the strike price of a short put? To demonstrate this, we’ll look at a situation where a trader sells an at-the-money put before the stock price drops significantly.

Here are the specifics of the next example:

Initial Stock Price: $109.99

Initial Implied Volatility: 27.5%

Strike and Expiration: 110 put expiring in 49 days

Put Sale Price: $4.20

Put Breakeven Price: $110 put strike price – $4.20 credit received = $105.80

Maximum Profit Potential: $4.20 credit received x 100 = $420

Maximum Loss Potential: $105.80 breakeven price x 100 = $10,580 (stock price at $0)

Let’s see what happens!

Short Put #3 Trade Results

In the first 14 days of this trade, the short put trader didn’t have significant profits or losses. However, things changed quickly when the stock price plummeted 10% after an earnings report.

With 21 days to expiration, the 110 put was worth $17, which is four times more than the initial sale price. At expiration, the stock price was $95, which meant the 110 put had $15 of intrinsic value. Unfortunately, this resulted in a loss of $1,080 per contract for the put seller: ($4.20 sale price – $15 expiration price) x 100 = -$1,080.

As mentioned earlier, it’s always possible to close the position early to lock in losses. For example, if this particular trader wanted to take their losses when the put traded $10, they could buy the put back and lock in $580 in losses: ($4.20 initial sale price – $10.00 purchase price) x 100 = -$580.

In summary, keep in mind that things don’t always work out when trading a high probability strategy such as selling puts. However, there’s always an exit opportunity if the losses get out of hand.

Final Word

Congratulations! You now know how selling put options works as a trading strategy. Be sure to revisit this guide often to solidify what you’ve learned.

In a nutshell, here is what we learned:

Short puts have great downside risk.
With decreasing extrinsic value, short puts have a greater chance of being assigned.
The maximum profit on short puts is limited to the credit received.
More premium can be collected from puts when the implied volatility is elevated

Next Lesson

Additional Resources

Explaining Put Options (Short and Long) – CME Group

Short Call Strategy Characteristics

Profit/Loss Potential at Expiration

Covered Call Profit/Loss

Short (Naked) Call Trade Examples

Trade Example #1: Profitable Short Call Trade

Short Call #1 Trade Results

Trade Example #2: Significant Short Call Loss

Short Call #2 Trade Results

Trade Example #3: Steadily Profitable Call Sale

Short Call #3 Trade Results

Final Word

Next Lesson

Shorting Put Options for Income Explained

Selling Call and Put Options Explained

Additional Resources

Bear Put Spread Strategy Characteristics

Profit/Loss Potential at Expiration

Long Put Spread Outcomes

Bear Put Spread Trade Examples

Trade Example #1: Low Probability Put Spread Purchase

Long Put Spread #1 Trade Results

Trade Example #2: Profitable Bear Put Spread

Long Put Spread #2 Trade Results

Trade Example #3:

Long Put Spread #3 Trade Results

Final Word

Next Lesson

Bull Call Spread Explained – The Ultimate Guide

Bull Put Spread Guide

The Vertical Spread Options Strategies: Beginner Basics

Additional Resources

Long Put General Characteristics

Expiration Profits/Losses for a Long Put Position

Long Put Option Trade Examples

Trade Example #1: Buying an At-the-Money Put

Long Put #1 Trade Results

Trade Example #2: Buying an Out-of-the-Money Put

Long Put #2 Trade Results

Trade Example #3: Buying an In-the-Money Put Option

Long Put #3 Trade Results

Final Word

Next Lesson

Call Options vs Put Options

Stocks vs Shares: How They Differ

Long vs Short Explained

Additional Resources

Synthetic Long Stock - Strategy Characteristics

Profit/Loss Potential at Expiration

Synthetic Long Stock Trade Example

Final Word

Next Lesson

Synthetic Short Stock Strategy (Guide w/ Examples)

7 Best Covered Call ETFs and How They Work

QYLD vs NUSI vs DIY: Which Options ETF Strategy is Best?

Additional Resources

Collar Options Strategy Characteristics

Collar Expiration P/L Example #1

Collar Trade Outcomes

Collar Expiration P/L Example #2

Collar Trade Outcomes

Collar Example Trades

Maximum Profit - Collar Trade Example #1

Collar #1 Trade Results

Maximum Loss - Collar Trade Example #2

Collar #2 Trade Results

Entering a Collar to Protect Share Profits - Trade Example #3

Collar #3 Trade Results

Final Word

Next Lesson

QYLD vs NUSI vs DIY: Which Options ETF Strategy is Best?

7 Covered Call ETFs

Additional Resources

Protective Put Options Strategy Characteristics

Protective Put: Profits/Losses at Expiration

Protective Put Trade Results

Protective Put at Different Expirations

Married Put (Protective Put) Trade Examples

Profitable Protective Put - Trade Example #1

Protective Put #1 Trade Results

Reducing Risk With a Protective Put - Trade Example #2