Covered Put: Overview, Uses, Example, Risks, Profitability

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Written by Arjun Remesh | Reviewed by Sunder Subramaniam | Updated on 25 April 2025

A covered put is an options trading strategy used by investors with a moderately bearish outlook on a stock. A covered put involves two simultaneous actions: short-selling shares of a stock and selling a put option on the same stock.

The goal is to generate income through the premium received from the put option while profiting from a potential decline in the stock price. This strategy is often employed when the investor expects the stock price to remain stable or fall slightly.

For example, if a stock is trading at Rs.50, an investor might short 100 shares and sell a put option with a Rs.45 strike price, earning a premium. The maximum profit occurs when the stock price falls to the strike price, while losses can be unlimited if the stock price rises significantly.

While this strategy can generate income, it carries risks such as unlimited potential loss and limited profit, making careful risk management essential.

What is a Covered Put?

A covered put is an advanced options trading strategy designed for bearish or neutral market conditions. It involves simultaneously short-selling a stock and selling a put option on the same security. 

By doing so, the trader collects a premium from the put option, which offsets some of the risks associated with the short position. This strategy is typically employed when the trader anticipates a gradual decline or stability in the stock’s price. 

It offers income potential through the premium, it carries significant risk, as losses can escalate if the stock price rises sharply against the short position.

How Does a Covered Put Work?

A covered put is a bearish options trading strategy that involves short-selling a stock and simultaneously selling a put option on the same stock. The goal is to generate income from the premium received for the put option while benefiting from a potential decline in the stock price. The payoff diagram for this strategy shows that profits are capped, but losses can grow significantly if the stock price rises. Look at the image below.

In the image above, observe how a covered put strategy gives a considerable buffer space for the stock price to correct and also keep the position slightly flat to profitable where the naked short future’s position will start incurring losses if the price of the stock rises even by 1 rupee.

 The payoff graph uploaded below is of a naked short futures contract. Observe how the breakeven is at the price at which the short position is created, the breakeven = price at which the stock was short sold. (1203.) This position contains the potential of unlimited profit and undefined losses. 

In the image below, we will see how the payoff of a covered put would look like: 

Observe how the breakeven has shifted to 1228 (2.20 % higher than the current market price) 

This buffer plays a crucial role in maintaining profitability in the short positions portfolio. While the profit potential is limited, the risk remains undefined. 

This is how a covered put strategy is useful in a flat to bearish market: it protects upside risk and also locking in the profit potential, providing opportunities to adjust risk management roles. 

What is the Maximum Profit & Loss on a Covered Put?

The maximum profit and maximum loss in a covered put strategy are directly tied to its components: short selling the stock and selling a put option.

• Maximum Profit: The profit is capped and occurs when the stock price falls to or below the strike price of the put option. It is calculated as the sum of the premium received from the put option and the difference between the short sale price and the strike price. For example, if you short a stock at Rs.50 and sell a Rs.45 strike put for Rs.2, your maximum profit is Rs.7 per share (Rs.50 – Rs.45 + Rs.2).
• Maximum Loss: The loss is theoretically unlimited because short selling exposes you to rising stock prices. If the stock price surges significantly, losses escalate with no upper limit. This makes risk management critical when using this bearish options trading strategy.

When to Use a Covered Put Strategy?

A covered put strategy should be used when an investor has a neutral to slightly bearish outlook on a stock or index. It is used when the trader expects the price to either remain range-bound or decline moderately. 

This strategy combines short-selling a stock and selling a put option, generating premium income that offsets some of the risks associated with the short position. It is particularly useful in stable or mildly bearish markets, as the premium received can enhance profitability and provide a buffer against small price increases.

However, this strategy should be avoided in bullish markets or when there is potential for significant upward price movement. 

A rising stock price can lead to unlimited losses due to the short-selling component, while the premium income from the put option may not sufficiently offset these losses. Additionally, it is unsuitable for extremely bearish scenarios, as profits are capped once the stock price falls to the put’s strike price.

Why Should You Use Covered Put?

A covered put strategy should be used to generate income and capitalize on a bearish or neutral market outlook. This strategy is particularly effective when the stock price is expected to decline slightly but remain above the strike price of the put option. Below are some more reasons why you should use covered put.

Income Generation

A covered put strategy is a popular method for generating income through the premium received from selling a put option. This premium provides immediate cash flow, offsetting some risks associated with short-selling the underlying stock. 

For example, if you short a stock at Rs.60 and sell a put option with a Rs.55 strike price for Rs.3, you earn Rs.3 per share as premium income. 

However, this strategy involves significant margin requirements, as short-selling requires maintaining collateral to cover potential losses if the stock price rises. While it offers income potential, traders must carefully manage risks and monitor margin obligations.

Hedge against Short

A hedge against a short position is a strategy used to limit the risks associated with short-selling by offsetting potential losses if the stock price rises. One common approach is to purchase a call option on the same stock. 

The call option provides the right to buy the stock at a predetermined strike price, which caps the cost of covering the short position if the stock price unexpectedly increases.

For example, if you short 100 shares of a stock at Rs.50 and buy a call option with a Rs.55 strike price for Rs.2, your maximum loss is limited. If the stock rises to Rs.60, you can exercise the call option to buy it back at Rs.55, reducing your loss from the short position. 

This strategy ensures that while you may incur some losses, they are controlled, making it an effective hedging tool against upward price movements.

Flexibility

A covered put strategy offers flexibility by allowing traders to adjust their positions based on market conditions. By combining short-selling with selling a put option, traders can generate income through the premium while maintaining the ability to adapt their approach. 

For example, if a stock is shorted at Rs.50 and a Rs.45 strike put is sold for Rs.3, the trader can choose to let the put expire if the stock price remains above Rs.45 or close the position early if market conditions change. This flexibility enables traders to manage risk, lock in profits, or adjust exposure based on evolving market trends.

How Option Greeks Affects Covered Put?

Option Greeks helps traders understand the risks and dynamics of a covered put strategy. 

• Delta: Delta measures the sensitivity of the option’s price to changes in the stock price. For a covered put, the Delta of the sold put option is negative, reflecting its bearish bias. As the stock price decreases, the short put gains value more slowly due to its Delta. 

Traders should monitor Delta to understand how price movements impact their position and adjust accordingly. Tools like options analytics platforms or brokerage dashboards can help track Delta in real-time.

• Theta: Theta represents time decay, showing how much an option’s value decreases as expiration approaches. In a covered put, Theta works in favor of the trader because the sold put option loses value over time. This decay accelerates as expiration nears. Traders should monitor Theta to ensure they’re benefiting from time decay while managing risk from other factors. Regularly reviewing options pricing on trading platforms helps track Theta’s impact on profitability.

• Vega: Vega measures an option’s sensitivity to changes in implied volatility. For a covered put, a decrease in volatility benefits the trader because it reduces the value of the sold put option. Conversely, rising volatility increases potential losses. Monitoring 

Vega is crucial during periods of market uncertainty or earnings announcements. Traders can use volatility charts or implied volatility metrics provided by trading platforms to assess Vega’s impact and adjust their strategy if necessary.

What is an Example of Trading Covered Put?

Let us understand trading covered put better with an example of reliance shares.

The payoff graph uploaded below is of a naked short futures contract. Observe how the breakeven is at the price at which the short position is created; the breakeven = price at which the stock was short sold. (1203.) This position contains the potential of unlimited profit and undefined losses. 

In the image below, we will see how the payoff of a covered put would look like: 

Observe how the breakeven has shifted to 1228 (2.20 % higher than the current market price) 

This buffer plays a crucial role in maintaining profitability in the short positions portfolio. While the profit potential is limited, the risk remains undefined. 

This is how a covered put strategy is useful in a flat to bearish market protecting upside risk and also locking in the profit potential providing opportunities to adjust risk management roles. 

This image represents a covered put strategy in Reliance, where the trader has sold a futures contract at Rs.1203 while also selling a 1200 strike put option at Rs.25.35 for 27th March 2025 expiry. The payoff chart shows a linear downward slope, indicating limited profit potential if the price drops and unlimited loss potential if the price rises, as the futures contract incurs losses in a bullish scenario. The breakeven point is at Rs.1203, meaning any price above this level results in losses, while profits increase as the stock declines. 

The probability of profit is 53.43%, and since no hedge is applied, the strategy relies on the expectation that Reliance will decline or stay below the breakeven level. This strategy is typically used when a trader has a bearish outlook on the stock and wants to maximize premium collection while being exposed to downside risk.

What is The Margin Requirement to Trade Covered Put?

The margin requirement for trading a covered put depends on the short stock position and the sold put option. In India, traders must meet SEBI’s margin regulations, which typically require 50% of the margin to be in cash or cash-equivalent securities. For a covered put, the margin is calculated based on the short stock position and the potential risk from the sold put option.

For example, if you short 100 shares of a stock a tRs.460 and sell a Rs.450 strike put for Rs.20, your broker will calculate the margin based on the short stock’s exposure and the risk of the put being exercised. The premium received (₹2,000) reduces the margin requirement slightly. However, since short-selling involves unlimited loss potential, brokers often demand higher margins to cover risks.

What are the Risks Involved in Trading Covered Put?

Trading a covered put strategy involves significant risks due to its reliance on short-selling and selling a put option. Below discussed are some.

• Unlimited Loss: The primary risk of a covered put is the potential for unlimited loss if the stock price rises significantly. Since the strategy involves short-selling, any upward price movement results in escalating losses, as there is no cap on how high a stock can go. For instance, if a stock shorted at Rs.460 rises to Rs.520, the loss per share is Rs.60, offset only slightly by the premium received. Traders must monitor market trends closely to mitigate this risk.

• Margin Calls: Covered puts require substantial margins due to the short-selling component. If the stock price rises sharply, brokers may issue margin calls, requiring traders to deposit additional funds or liquidate positions to cover potential losses. For example, if a stock rises unexpectedly, the margin requirement increases. Monitoring margin levels through brokerage platforms and maintaining sufficient collateral can help avoid forced liquidations.

• Opportunity Costs: By committing capital to a covered put strategy, traders forgo other investment opportunities that might offer better returns. For instance, if a stock stabilizes instead of declining as anticipated, the trader’s profit is limited to the premium received. 

This lost opportunity could have been better utilized in more favorable trades or investments with higher growth potential. Regularly reassessing market conditions helps minimize this cost.

Is Covered Put Strategy Profitable?

Yes, a covered put strategy is profitable under the right market conditions, particularly in neutral to moderately bearish trends. The strategy combines short-selling a stock and selling a put option, allowing traders to generate income through the premium received from the put while profiting from a potential decline in the stock price.

For instance, a stock is shorted at Rs.460 and an out-of-the-money put option with a Rs.450 strike price is sold for Rs.20, the trader earns Rs.2,000 in premium upfront. If the stock price drops to Rs.450, the trader achieves maximum profit by covering the short position at Rs.450, retaining the premium. However, profits are capped at this level, as further declines in stock price are offset by losses on the sold put.

Is Covered Put Bullish or Bearish?

A covered put strategy is bearish or neutral to bearish. It is executed when a trader expects the price of a stock or index to decline moderately or stay within a narrow range. This strategy involves short-selling the stock and simultaneously selling a put option, benefiting from the premium income and potential profits from a falling stock price. 

What is the Difference Between Covered Put vs Covered Call?

The key difference between a covered put and a covered call lies in their market outlook and structure. A covered put is a bearish strategy where the trader short-sells a stock and sells a put option, profiting from a price decline. 

In contrast, a covered call is a bullish to neutral strategy where the trader owns the stock and sells a call option, earning premium income while capping upside potential. Covered puts carry unlimited risk, while covered calls limit losses to the stock’s purchase price.

What is the Difference Between Covered Put vs Naked Put?

The primary difference between a covered put and a naked put lies in the associated positions and risk levels. A covered put involves short-selling the underlying stock and selling a put option simultaneously, which partially offsets losses if the stock price falls. 

In contrast, a naked put involves selling a put option without holding any corresponding position in the underlying stock, exposing the trader to significant risk if the stock price drops sharply. Covered puts are more conservative, while naked puts carry higher risks but require less initial capital.

What are Alternatives to Covered Put Strategy?

The following are the alternatives to covered put strategy.

1. Naked Put: Selling a put option without shorting the underlying stock. It generates premium income but carries significant risk if the stock price falls sharply.
2. Bear Put Spread: Involves buying a put option and simultaneously selling another put at a lower strike price to limit both potential losses and gains.
3. Iron Condor: A neutral strategy that profits from low volatility by combining a bull put spread and a bear call spread, offering limited risk and reward.