When you have options, you have the right to sell them. You are able to sell a certain quantity at a certain price and this is done within a specific period of time.
Covered puts is the easiest way in which you can sell your options. Any time an options trader is bearish on a certain security, the put options can be purchased in order to profit when a slide in the asset price occurs. However, when a strike price is set, the price must drop well below that strike price and before the expiration date of the option in order to make a profit from this strategy.
Perhaps a stock that you have invested in is ABC Plastics. Right now they are trading at $30. This option expires in a month and the price it is being priced at is $2. You believe that the stock is going to take a sharp decline after the company's earning report comes out. Because of this, you have paid $200 for a single $30 ABC option and this $200 covers 100 shares.
Perhaps your belief was correct and the price of each share dropped to $20. Because of this plunge, you will receive $1000. Because you paid out $200 to cover the 100 shares, your profit will be $800.
This is a strategy that is referred to as a "long put strategy."
Rather than purchase your put options, you can sell them as well and you can sell them for a profit - somewhat similar to stock option covered calls. The hope is that put options will expire and be worthless so that the premiums can be pocketed. The risk that is associated with selling puts can be risky, but it can be profitable if it is done properly.
In the case of covered puts, the put option is covered if the seller is short on the amount of underlying security. This strategy is implemented when the investor is bearish on the underlying asset.
Basically, covered puts involve shorting the underlying stock of its obligated shares. The profits are limited, but the risk is not very high. The maximum gain is equal to the premiums that are received when the options are sold. Basically, there is an unlimited upside risk.
The risk of the option increases if the stock suddenly increases in price. Since there is no limit to how high a stock price can go, the amount of risk that is involved is unlimited as well. What you want is a stock that is not going to change in price by the expiration date or one that is going to rapidly decline before the expiration date. If it does, then you have beaten the stock by the expiration and can pocket the premiums.
An example of how this works is this: If ABC Plastics is trading at $35 in June and an options trader writes a covered put by selling a JUL 35 for $200 while shorting 100 shares of ABC stock, there is a credit of $200 that is taken in order to enter this position.
When the expiration date in July comes and the option is still trading at $35 and it expires, then the premium is pocketed and there is no loss. This means that all profit is taken by the investor. If the stock would increase to $45, then a loss is going to be taken and there is going to be a loss.
Knowing how stock option covered puts work can help you to develop a strategy that will make you profitable and a certified financial advisor can help you with this.
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