Short Put Option: Overview, Strategy, Example, Advantages & Risks

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The short put is an option’s strategy where a trader sells a put option. The short put option strategy is executed when the underlying stock is expected to stay neutral to bullish. Meaning, the put seller/writer will only earn money if the underlying stock remains neutral or bullish.

The short put option’s strategy has been in use since the inception of options trading. Traders first started selling options in 1973 in a standardised manner when the Chicago Board Options Exchange was established in 

A short put option’s strategy is similar to the act of buying an option’s contract, except that the short put has a potential of limited profits and substantial losses contrary to call option buying. 

A simple short put strategy that many investors use is to sell a put option in a stock which is expected to stay flat or rise in value. 

What is a Short Put?

A short put is a single legged option selling strategy. A short put or an unprotected put is a neutral to bullish option strategy where a trader sells a put option in the anticipation that the underlying stock will either stay flat or appreciate in value.  A short put  generates profit when the option contract value drops or goes worthless. . Executing a short put options strategy requires a trader/investor to sell a naked option contract. 

A short put writer/put seller is obligated to buy the underlying shares of the stock if the option buyer decides to exercise the option contract. The option writer will earn the option premium which is the price at which the option is sold. The option writer’s profit is limited to the option premium while his/her risk is unlimited. 

A short put options strategy lets a trader/investor be bullish in a stock without directly owning shares or buying call options. 

How Does a Short Put Work?

A short put strategy involves selling a put option contract on an underlying stock. This strategy is ideal for traders who are bullish on a stock but prefer not to buy it directly or purchase call options. By selling a put option, the trader receives a premium upfront and grants the buyer the right to sell the stock at a predetermined price (strike price) within a specific timeframe.

Unlike buying a put option and then selling it later, this strategy involves directly selling the put contract, exposing the trader to the risk of being assigned the stock if its price falls below the strike price.

For example, suppose you want to enter into a stock at Rs.150 but the stock is currently trading at Rs.160. In this case, selling a put option worth supposed Rs. 20 with a strike price of Rs.150 means if the stock falls below Rs.150 you will be required to buy that stock at Rs.150 or the premium worth Rs 20 will decrease to suppose 15 Rs giving the writer profit of 5 Rs per lot. The benefit is that you earned the option premium while executing a short put. You will still keep the premium earned even if the underlying stock does not fall below Rs.150. 

The position will stay profitable even if the underlying asset closes at Rs 150 by expiry as the strike sold was Rs 150 put option. 

However, here are 3 parameters a trader/investor should always know about before executing a short put options strategy – 

• Short Put Payoff Formula – 

Payoff = Premium Received – Max (0, Strike Price – Stock Price)

Where, 

Premium Received is the fixed amount of money received upfront when selling a put option contract. 

Max (0, Strike Price – Stock Price) represents the potential loss. It is the maximum of zero and the difference between the strike price and the stock price.

For example, suppose you sell a put option on a stock with a strike price of Rs. 100 for a premium of Rs. 5.

• If the stock price at expiration is Rs. 110:
  • Max(0, 100 – 110) = 0
  • Payoff = Rs. 5 – 0 =  Rs. 5 (Profit)
• If the stock price at expiration is Rs. 90:
  • Max(0, 100 – 90) = Rs.10
  • Payoff = Rs. 5 – Rs. 10 = -Rs. 5 (Loss)

Remember, Max(0, Strike Price – Stock Price) represents your potential loss. The option contract expires worthless If the stock price is higher than the strike price and you do not suffer a loss. If the stock price is lower than the strike price, you are obligated to buy the stock at the strike price, incurring a loss equal to the difference between the strike price and the stock price.

The overall payoff is the premium received minus the potential loss.

Add an example to explain the formula

• Short Put Payoff Diagram – 

The profit potential in a short put strategy is always limited to an option’s premium. While the risk of loss is theoretically unlimited. As you can see above, the short put will move towards its maximum profit potential whenever the underlying asset starts to rise. Conversely, it moves towards its maximum loss potential when the underlying assets start to decline. 

• Breakeven for Short Put – 

A breakeven point is a situation where the trader is not having a gain as well as he is not incurring losses. The point A in the above diagram refers to the breakeven point for the short put. 

A formula to track the breakeven point for a short put is – 

Short put B/E = strike price – initial option price (Premium received)

Why Use a Short Put Strategy?

Traders use a short put strategy when they believe that the underlying stock will keep rising or won’t slide below a certain level. Using a short put strategy lets a trader utilize the slow and steady upwards movement in the underlying stock by earning an option premium. A trader commits to purchase the underlying stock at a predetermined level and time when executing a short put strategy. 

Short put strategy is useful in bullish markets where traders tend to use technical charts to establish a support structure and sell strike prices near the support level to book profits. The position will stay profitable until the underlying asset’s price closes at or above the strike price. 

How to Trade Short Puts?

Trading short puts is done in 2 steps. The following 2 steps describe a method of trading short puts. 

• Entering a short put – 

A trader has to execute a market/limit order on his dematerialized account for entering a short put trade. Market order executes the order at the ask price and the limit order is executed at the minimum price a trader is willing to enter the trade. 

A broker will require additional margins when shorting an option contract as it contains unlimited risk. For example, if you sell a put option of Rs.100 strike price, the margin required to execute the order can range from Rs.50-60 thousand. 

Once a trader pays the required margin, the trade is executed and he has entered in a short put trade.

• Exiting a short put – 

There are multiple ways to exit a short put contract. A trader can execute a normal “Buy” order to exit or he can let the option buyer decide when to exercise the option contract. In the latter scenario, an option seller will have to buy the shares of the underlying stock at the current market price. 

The option contract is automatically assigned to the option seller if the short put option expires In-The-Money (ITM). And the option will expire worthless if the stock price is above the strike price and the option contract is Out-Of-The-Money at expiration. 

In most cases, options traders exit short put positions by buying back the sold option before expiration to lock in profits or manage risk. Assignment, where the trader must purchase the underlying stock at the strike price, is rare as many traders prefer not to hold the position until expiry, especially if the option is in-the-money (ITM).

A trader incurs losses when the option contract is bought back at more premium than initially sold. Conversely, a profit is gained when the option is bought back for less premium than initially sold. 

Example of Short Put Trading

Following is an example of short put trading in Reliance Industries. 

Reliance Industries faced a sell-off in the period from July to October 2023 and formed a strong bullish candlestick pattern on a weekly candlestick. 

Mr. A wants to buy Reliance Industries but he does not have enough cash to buy 100 shares of Reliance at Rs.1000 which would require Rs.100,000.

Instead, Mr. A decided to short a put option contract. 

Look at the image above, after the bullish weekly candle closed on friday of 30 october 2023, Mr. A would have sold a put option of safer strike prices 1110 and below by the virtue that the support structure is strong enough to hold the price till the upcoming expiry. 

This analysis stands out to be a logical one and he potentially books profit anytime before expiry as the time decay assist the premium price of the strike price to decay and give profits to Mr. A’s position. 

This means that Mr. A thinks Reliance Industries will rebound and not fall below its current levels around 1130. 

If Reliance Industries continues to fall, Mr. A could theoretically face unlimited losses or he may choose to offset losing position by implementing hedging strategies. But if the stock moves in his favor, the option contract sold will get Out-of-the-Money (OTM) and it will expire worthless. This will earn Mr.A a profit. 

Mr. A’s analysis proves to be right and Reliance Industries rebounds and touches Rs.1100-1120 levels in the coming months. This results in Mr. A earning a profit as the short put option contract expires worthless in November 2023’s expiry. 

What are the Popular Short Put Strategies?

Popular short put option trading strategies are the ones traders use whenever they want to maximize their profit or safeguard their capital. Following are the 5 most popular short put strategies every trader/investor should know. 

1. Cash-Secured Put

Cash-Secured Put or Cash-Covered Put strategy is an options income strategy. A cash-secured put is considered to be a secure strategy when compared to other option strategies. 

In this option’s strategy, a trader sells a put option of an underlying stock and sets aside the trade’s equivalent capital in his demat account in case the option buyer exercises his right. For example, the option seller earns a profit when the underlying stock’s price trades above the option’s strike price. Conversely, the option seller loses when the underlying stock falls below the strike price. 

In this situation, the option buyer can be tempted to exercise his rights which would result in the option seller forcibly buying the underlying stock. Hence, the necessary funds in the demat account is a crucial part of this strategy. 

For example, let’s assume that Reliance Industries is trading at Rs.1320. Mr. B believes that Reliance will not go below Rs.1320 and hence he sells a put option of Rs.1320 at Rs.22.3 expiring on 26th december. Now, the maximum loss Mr.B can face is substantial and he will also have to keep aside an extra Rs.1 lakh (The value of the trade) in his demat if he has to buy back the stocks. On the other hand, the potential profit he can earn is Rs.11,000. There are two possible scenarios that can work out – 

• Reliance rises and does not fall below Rs,1320 levels resulting in a profit for Mr.B 
• Reliance falls at Rs 1300. Let’s assume the premium also falls Rs.20 from the levels Mr.B sold the option contract. In this case, he loses Rs.2000. 

2. Naked Put Selling

Naked Put selling involves selling of the put option contract only. Naked put or uncovered put strategy is a single legged strategy. Meaning, a trader executing this strategy does not hedge his position by executing a short trade in the underlying stock.

A naked put selling strategy gives a trader the obligation to buy the underlying shares of the stock if the option is exercised The maximum risk in this strategy is theoretically unlimited until the stock reaches zero. While, the maximum profit is limited to the option’s premium. Investors/Traders generally use this strategy when they are almost certain that the underlying stock will not fall from the current levels and earn a decent passive income from it. 

The same example as above can be taken here while the only catch being that an option seller does not hedge in any form after selling the put option. For example, Mr. A believes that Reliance will not go below Rs.1320 and hence he sells a put option of Rs.1320 at Rs.22.3 expiring on 26th December. Then, the maximum risk here will be substantial. And the investor will start generating income as soon as the stock does not fall below and keeps rising. 

This strategy is considered very risky because unlike a covered put strategy, the trader/investor here is exposed to large downwards moves that can potentially lead to unlimited losses. 

Another example of selling a naked put can be right before a company is expected to report strong quarterly earnings. This further accelerates the chance of profit as the stock will most probably keep rising due to its strong fundamentals.

3. Short Put Spread

A short put spread option strategy is a type of income generating strategy. A short put spread involves selling of a put option of a higher strike price while also buying a put option of the same underlying asset but of a lower strike price. Both of these contracts have similar expiration dates. 

The idea behind short put spread is that the underlying stock should stay above the higher strike price. This allows the sold put option to expire worthless while the bought put option limits the trader’s potential losses. This strategy is less risky when compared with naked put selling or cash secured put option strategy as it limits both the potential profit as well as the maximum loss. 

For example, let’s assume Tata Motors is trading at Rs.820. Mr.A, who is expecting Tata Motors stock to remain above Rs.820  levels, executes a short put spread strategy by selling a put option with a strike price of Rs. 810 and simultaneously he buys a put option with a strike price of Rs.800.

Now, only 3 possible scenarios can play out – 

Scenario Number 1 – 

If Tata Motors remains above Rs.820 levels then this will be the ideal scenario for Mr. A as the sold put option will become worthless resulting in a profit. The bought put option will give some losses but it will be overshadowed by the sold put option’s profit. 

Scenario Number 2 – 

If Tata Motors goes sideways between the range of Rs.820-810 levels then Mr.A will suffer a minor loss as the sold put option contract will rise in value. This loss will be offset to some degree by the put option bought. 

Scenario Number 3 – 

If Tata Motors falls and goes below the Rs.810 levels then Mr.A will suffer a huge loss as the sold put option will rise in value significantly. The bought put option will offset some losses but the overall loss will be huge. 

This way the short put spread option strategy helps investors/traders by providing them a less risky way of generating income through selling options

These spreads are also known as put credit spreads and these are amongst the most popular put short strategies. Traders experience different types of put credit spreads and implement these in index option selling. 

4. Covered Put

A covered put is an options strategy where an investor sells a put option while simultaneously holding a short position in the underlying stock. A covered put option strategy is considered a moderately bearish strategy. This strategy offers a way to generate income through options premiums while also having a hedge in place through the short stock position. 

This strategy is mainly used when the investor believes the stock’s price will trade in a narrower range and decline moderately, and they’re willing to take on the obligation to buy the stock at the strike price if the put option is exercised.

In a covered put strategy, the trader sells a put option on a stock they have shorted. This means the trader is betting that the price of the stock will not go above the strike price of the put option. If the stock falls, the put option can expire worthless, and the trader can keep the premium. However, if the stock rises, the trader may be obligated to buy the stock at the put’s strike price, but they are already short the stock, so their risk is somewhat mitigated by the position they hold.

For example, let’s assume Titan Ltd. is currently trading at Rs.3460, and Mr. X believes that the stock price will not rise above Rs.3460, and he also expects a moderate decline in the stock’s price. Therefore, Mr. X can execute a covered put strategy by selling a put option with a strike price of Rs.3450 and shorting 100 shares of Titan Ltd. at Rs.3450 simultaneously.

Now, let’s have a look at the 2 possible outcomes from this strategy – 

Outcome number 1 – 

If Titan’s stock price falls below moderately or stays at Rs.3460 then the put option will likely expire worthless and Mr.X will earn the sold put’s premium. Mr.X will also earn from his underlying short position in the stock as a result of the fall in the price. Overall, Mr.X will earn from both of his positions.

Outcome number 2 – 

If Titan’s price rises above Rs.3460 then the put option will likely be exercised and Mr.X will be obligated to buy the stock at Rs. (Which is the strike price). Also, Mr.X’s underlying short position in the stock will end up giving him losses. While the sold put option offsets some of his losses, Mr.X will suffer a minor loss overall. 

5. Rolling a Short Put

Rolling a short put option strategy involves closing an existing short put position by buying back the put option before it expires. Rolling a short put also requires a trader/investor to simultaneously sell another put option having a later expiration date or a different strike price. 

Traders/Investors use this strategy to manage risk, extend their position’s duration or adjust the trade according to the changing market condition. Rolling a short put option strategy helps traders/investors in avoiding the potential assignment (Being forced to buy the stock) or in aiming for further premium income while maintaining control of their position. 

When a trader/investor sells a put option, they are then obligated to buy the underlying stock if the price falls below the strike price. And if the stock is approaching the strike price or if the trader/investor wishes to extend their trade duration then they can roll the short put. Rolling short put means buying back the current short put position while selling another put option with a new expiration date or different strike price.

For example, let’s assume Asian Paints is trading at Rs.2450 and Mr.Y has sold a put option with a strike price of Rs.43.5 which is expiring in a week. The stock has fallen to Rs.2440 as the expiration date is approaching. As a result, Mr.Y is concerned that if the stock continues to drop it will put his position at risk. 

To manage the risk and avoid having to buy the underlying stock, Mr.Y decides to roll his short put position by booking the loss in his current trade and selling a new put option with a strike price of Rs.2440 with a later expiration date. 

By doing this, Mr. Y avoids assignment, extends the trade, and collects more premium.

What’s the Advantage of Short Put over Other Strategies?

Short put certainly has advantages over other option strategies. Following are the 4 advantages short put has over other option strategies. 

• Short Put vs Long Put

Short Put involves selling an option. Here, a trader receives the option premium upfront. As long as the stock stays above the strike price, a trader is profitable with no further risk.

On the other hand, In a Long Put, a trader has to pay for the option and the stock has to drop significantly for it to be profitable. Meaning, the long put strategy is often not profitable whenever the market is range-bound or slightly bearish. 

• Covered Call vs Short Put

A Covered Call option strategy requires a trader to own the underlying stock and sell a call option on it. While the Short Put strategy does not involve a trader owning the underlying stock. Instead, he/she can sell a put directly. 

The covered call strategy often limits your upside potential if the stock rises sharply. Whereas,  the short put strategy provides a good alternative for generating premium income without owning the underlying stock. 

• Short Straddles/strangles vs Short Put

A Short Straddle requires a trader to sell both a put and a call option at the same strike price and a Short Strangle involves selling a put and a call option at different strike prices. While these strategies are deployed when there is low volatility in the market, they always carry the risk of the market moving in any one direction significantly. 

The Short Put option strategy has a lower risk compared to short straddles/strangles because it only involves one side of the trade (Just the put option) while straddles/strangles can expose a trade to the risk of stock moving significantly in either direction which can lead to a massive loss. 

• Selling Naked Puts vs Covered Puts

A naked put involves selling of a put option without having any hedge position. Whereas, a covered put strategy involves selling a put option while shorting the underlying stock simultaneously. 

A naked put is a simpler strategy to execute with a more defined risk when compared to shorting stocks. Selling naked puts offer better flexibility if you are comfortable with the associated risk. 

How Option Greeks Affects Short Put?

Option Greeks affect the short put strategy in various ways. Option Greeks affect the short put because they are mathematical variables that reflect the sensitivity of an option’s price to changes in the underlying factors. Following are the 4 option greeks and its relation with the short put. 

• Delta and Short Put 

Delta measures how much the price of an option is expected to change when the underlying stock moves by one unit. In simple words, delta measures the sensitivity of an option’s price relative to the movements in the underlying stock. 

Your delta is positive whenever you sell a put option. Meaning, the value of your short put decreases whenever the stock price rises. Conversely, the value of your short put increases whenever the stock price drops. 

For example, Assuming the delta of the option you have sold is -0.40. Your short put option will lose Rs.0.40 whenever the underlying stock goes up by Rs.1 and vice versa. 

• Theta and Short Put

Theta measures the time value of an option contract. Meaning, it shows how much an option’s price will decrease as it approaches its expiration date.

Theta is always considered your friend whenever you sell an option. This is because you benefit from the passage of time as the option’s value decreases. The more time passes, the less likely the option buyer will exercise the option and the more premium you earn. 

For example, the value of your short put will decrease by Rs.0.05 every day if the theta of your sold put option is 0.05. 

• Vega & Short Put

Vega measures the sensitivity of an option’s price relative to the changes in the volatility of the underlying stock. An option becomes more expensive as the volatility increases and it becomes cheaper as the volatility decreases. 

For short put, vega can be both beneficial as well as harmful. You can face a loss whenever the volatility increases as it drives the option prices up. This is why an option seller always wants the volatility to remain as low as possible. 

For example, if the vega of your short put option is 0.10 and the implied volatility increases by 5% then it will result in an increase of Rs.0.50 in the price of your option. 

• Rho & Short Put

Rho measures the sensitivity of an option’s price relative to changes in the interest rates. A positive Rho means that the option price will increase if the interest rates rise and vice versa. 

Meaning, Rho is typically positive for option selling if the interest rates rise. For example, if the interest rates rise by 1%, it will cause your short put option to lose value as the option becomes less lucrative for the buyers. 

Rho has a smaller impact on option prices when compared to other option greeks. 

Are Short Puts Risky?

Yes, short puts are risky. Short Puts are risky like every other option strategy. Here are 4 factors you should know before executing a short put strategy. 

• Risk/Reward Ratio

A Risk/Reward ratio is a key factor in any given trade. In a short put strategy, the reward is limited to the premium collected. Meaning, the maximum profit an investor/trader can earn is when the option premium goes zero in value. 

While the risk for short put strategy is theoretically unlimited. Meaning, there is no limit as to how low a stock can go. This is why the Risk/Reward ratio for short put strategy seems a little unfavorable when  managed unprofessionally. 

• Margin Requirements 

A margin is a crucial factor when it comes to option selling. Whenever a trader/investor sells an option, the broker always asks to have enough capital set aside to cover the potential purchase. 

Selling options requires significant margins compared to buying options. This higher requirement can significantly increase one’s exposure to risk. Hence, a short-put strategy requires careful capital management and the ability to meet margin calls whenever necessary. 

• Theta Decay

Theta decay refers to the decrease in an option’s value as it nears expiration date. Theta decay is always considered as a friend of an option seller. This is until the underlying stock does not fall significantly. The time decay will not be enough to offset your losses if the underlying stock starts to decline sharply. 

• Volatility

Higher volatility in the market is not good for option sellers. Meaning, whenever the Implied Volatility (IV) is higher, the options increase in value and whenever the IV is lower, the options lose in value. 

A sudden increase in the volatility can cause a significant rise in the option’s value anytime. 

How to Protect a Short Put?

Protecting a short put trade requires traders to deploy a hedge. Protecting a short put trade involves a trader executing other option strategies such as short put spread or covered put. 

Option selling requires a trader to master the act of hedging. Hedging means to deploy counter trades whenever the market is going against your position to offset your losses. 

Is Short Put Bullish or Bearish?

A short put is a bullish strategy. A short put is bullish because a trader deploying this strategy earns whenever the underlying stock rises. 

What is the Maximum Profit on a Short Put?

The maximum profit on a short put is limited. The maximum profit on a short put can be gained only to the extent of the option premium. 

What is the Maximum Loss on a Short Put?

The maximum loss on a short put is the difference between the strike price of the put option and the premium received when selling it, essentially meaning the maximum loss occurs if the underlying stock price falls to zero at expiration; however, this loss is still capped at the strike price minus the premium collected.

Should You Trade Short Put if You Are a Novice?

No, you should avoid trading short puts if you are a novice. Option selling requires a trader to be a master in hedging and money management. As a novice, you should focus on developing these skills first. 

What is a Short Put Spread?

A short put spread involves selling of a put option while also buying a put option of the same underlying asset but of a lower strike price. 

What Happens When a Short Put Expires In The Money?

There are two possible scenarios that happen when a short put expires in the money. 

Scenario Number 1 – 

If the short put is expiring in the money then it means the underlying stock has fallen below the option’s strike price. This can result in the option buyer deciding to exercise his rights and as a result you will have to buy the underlying stock at the agreed upon strike price. 

Scenario Number 2 –

You sell the put before the buyer exercises his rights. This will result in losses but you will not have to buy the underlying stock in this case. 

If you sell the put option before expiration, you can avoid the obligation of buying the underlying stock. However, you may realize a loss from the position because the put option would have gained value as the stock price dropped. This will result in losses, but you will not have to buy the underlying stock in this case.

What Happens When a Short Put Expires Out of The Money?

A short put expiring out of the money is an ideal scenario for the option seller. A trader will realize maximum profits whenever a short put expires out of the money as the option is now worthless.
The option seller keeps the entire premium received for selling the option, without the need to buy the underlying stock.