An investor who sells a put believes that the underlying stock price will rise and that they will be able to profit from a rise in the stock price by selling puts. An investor who sells a put is obligated to purchase the underlying stock if the buyer decides to exercise the option. An investor who sells a put may also be selling the put as a way to acquire the underlying security at a cheaper price. If the stock is put to the investor, the investor’s purchase price is reduced by the amount of the premium received. When looking to establish a position the seller must determine:

  • Their Maximum Gain
  • Their Maximum Loss
  • Their Breakeven

Maximum Gain Short Puts

For an investor who has sold uncovered or naked puts, maximum gain is always limited to the amount of the premium they received when they sold the puts.

Maximum Loss Short Puts

An investor who has sold a put believes that the stock price will rise. There is, however, a limit to how far a stock price may decline. A stock price may never fall below zero. As a result, the investor who believes that the stock price will rise has a limited maximum loss. The worst thing that can happen for an investor who is short a put is that the stock goes to zero and they are forced to purchase it at the strike price from the owner of the put. To determine the maximum loss for the seller of a put use the following formula:

Maximum Loss = Strike Price – Premium

Determining The Breakeven for Short Puts

Whenever an investor has sold a put, they believe that the stock price will rise. If the stock price begins to fall, the investor becomes subject to loss. In order for the investor to breakeven on the transaction, the stock price may fall by the amount of the premium they received for the option. At expiration the investor will breakeven at the following point:

Breakeven = Strike Price – Premium

Example:

An investor has established the following option position: Short 1 XYZ May 30 put at 4

The Investor’s maximum gain, maximum loss, and breakeven will be:

Maximum Gain: $400 (The amount of the premium received)

Maximum Loss $26 or $2,600 for the whole position (Strike Price – Premium) Breakeven = $26 = 30-4 (Strike Price - Premium)

If at expiration XYZ is at exactly $26 per share and the investor closes out the position with a closing purchase or has the option exercised against them, they will breakeven, excluding transactions costs.

Notice the relationship between the buyer and the seller:

Put Buyer Put Seller

Maximum Gain

Strike Price - Premium

Premium Received

Maximum Loss

Premium Paid

Strike Price - Premium

Breakeven

Strike price - Premium

Strike price - Premium

Wants Option To

Exercise

Expire

Because an option is a two-party contract, the buyer’s maximum gain is the seller’s maximum loss and the buyer’s maximum loss is the seller’s maximum gain. Both the buyer and the seller will breakeven at the same point.

Need Help Passing Your Series 4 Exam?

Option Premiums

Related Articles
  1. Trading

    Bear Put Spreads: A Roaring Alternative To Short Selling

    This strategy allows you to stop chasing losses when you're feeling bearish.
  2. Trading

    Solving Mixed Options Problems On The Series 7

    Learn to ace the questions that involve both options contracts and stock positions.
  3. Trading

    Introduction To Put Writing

    Learn about a strategy that may be appropriate if you have a positive outlook on a stock.
  4. Trading

    Option Strategies For A Down Market

    All investors should be aware that the best time to buy stocks is when the market is tanking, according to history.
  5. Trading

    Difference Between Short Selling And Put Options

    Short selling and put options are used to speculate on a potential decline in a security or index or hedge downside risk in a portfolio or stock.
  6. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  7. Trading

    When Should I Sell A Put Option Vs A Call Option?

    Beginning traders often ask not when they should buy options, but rather, when they should sell them.
  8. Trading

    Prices Plunging? Buy A Put!

    You can make money on a falling stock. Find out how going long on a put can lead to profits.
  9. Trading

    What Is A Bull Put Spread?

    Investopedia explains: A bull put spread is a variation of the popular put writing strategy, in which an options investor writes a put on a stock to collect premium income and perhaps buy the ...
  10. Investing

    What is the Breakeven Point?

    In general, when gains or revenue earned equals the money spent to earn the gains or revenue, you’ve hit the breakeven point.
Frequently Asked Questions
  1. When are Beneficiaries of a Will Notified?

    Learn when the beneficiaries of a will must be notified, and understand how this requirement varies depending on whether ...
  2. Why Does Larry Page Pay Himself a $1 Salary?

    Google co-founder Larry Page continues to take an annual salary of only $1 as chief executive officer.
  3. What is Common Stock and Preferred Stock?

    Learn about the differences between common and preferred shares. Explore situations where preferred shares have more favorable ...
  4. Can CareCredit be Used for Family Members?

    Learn more about the available options that CareCredit offers to pay for out-of-pocket medical procedures with little to ...
Trading Center