The Covered Put

The Covered Put

The covered call is probably the most popular option strategy used today. It is very simple. Most investors tend to be long stocks and the idea of writing a call option, collecting some premium and being willing to accept a higher price for your underlying equity position appeals to many investors. Covered calls can provide some decent income and limited downside protection while you are waiting for your stock to appreciate to your desired exit price.

The married put is similarly another simple option play that is very common. With a married put, the investor will purchase a stock or an ETF then buy a put for insurance to protect the downside. With a married put the risk is limited and the upside reward in theoretically unlimited.

The covered put is not commonly used at all, yet can be a good strategy. Most investors don’t short stocks, so it is not nearly as common as the two strategies mentioned above. The covered put is just about the opposite of the covered call. The investor will identify a stock or ETF that he thinks has topped out and believes that it’s time for a short position. The stock is sold short and then a put option is sold on that position at a price point that the investor will be happy to buy the stock back. The profits to the downside are limited to the strike price selected and the premium received for the sale of the put. Just like a covered call there is risk to adverse price movement in the underlying, but now it is to the upside.

So, if you think that ABC stock won’t go any higher, you could short ABC say at $25. Then you could sell a $20 put say for $1. If ABC goes below $20 you’ll get assigned, buy the stock back at $20 and close out your position for a $6 profit. The percent return that you’d receive depends on the margin rate that you get from your broker.

Shorting stocks isn’t for everybody, but the covered put can be a viable strategy. As always it’s wise to do some thorough research and avoid stocks that could be potential takeover candidates or that could experience rapid price appreciation for some other reason like a new product announcement, lawsuit getting settled etc. Investors who rely on technical analysis alone should review the fundamentals to see if there are issues like that pending that could impact the price.

Married Put P/L Graph

P/L Graph for a Married Put

 

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About sellacalloption

Author, Radio Show Host and Portfolio manager and chief option strategist for IWC Asset Management.

Posted on March 4, 2012, in Bearish Option Strategies and tagged , , . Bookmark the permalink. Leave a comment.

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