What is a 'Short Put'

A short put refers to when a trader opens an options trade by selling or writing a put option. The trader who buys the put option is long that option, and the trader who wrote that option is short. The writer (short) of the put option receives the premium (option cost), and the profit on the trade is limited to that premium. 

Breaking Down the 'Short Put'

A short put is also known as an uncovered put or a naked put. If an investor writes a put option, that investor is obligated to purchase shares of the underlying stock if the put option buyer exercises the option. The short put holder could also face a substantial loss prior to the buyer exercising, or the option expiring, if the price of the underlying falls below the strike price of the short put option. 

Short Put Mechanics

A short put occurs if a trade is opened by selling a put. For this action, the writer (seller) receives a premium for writing an option. The writer's profit on the option is limited to that premium received. 

Initiating an option trade to open a position by selling a put is different than buying an option and then selling it. In the latter, the sell order is used to close a position and lock in a profit or loss. In the former, the sell (writing) is opening the put position.

If a trader initiates a short put, they likely believe the price of the underlying will stay above the strike price of the written put. If the price of the underlying stays above the strike price of the put option, the option will expire worthless and the writer gets to keep the premium. If the price of the underlying falls below the strike price, the writer faces potential losses.

Some traders use a short put to buy the underlying security. For example, assume you want to buy a stock at $25, but it currently trades at $27. Selling a put option with a strike of $25 means if the price falls below $25 you will be required to buy that stock at $25, which you wanted to do anyway. The benefit is that you received a premium for writing the option. If you received a $1 premium for writing the option, then you have effectively reduced your purchase price to $24. If the price of the underlying doesn't drop below $25, you still keep the $1 premium.

Risk

The profit on a short put is limited to the premium received, but the risk can be significant. When writing a put, the writer is required to buy the underlying at the strike price. If the price of the underlying falls below the strike price, the put writer could face a significant loss. For example, if the put strike price is $25, and price of the underlying falls to $20, the put writer is facing a loss of $5 per share (less the premium received). They can close out the option trade (buy an option to offset the short) to realize the loss, or let the option expire which will cause the option to be exercised and the put writer will own the underlying at $25.

If the option is exercised and the writer needs to buy the shares, this will require an additional cash outlay. In this case, for every short put contract the trader will need to buy $2,500 worth of stock ($25 x 100 shares).

Short Put Example

Assume an investor is bullish on hypothetical stock XYZ Corporation, which is currently trading at $30 per share. The investor believes the stock will steadily rise to $40 over the next several months. The trader could simply buy shares, but this requires $3,000 in capital to buy 100 shares. Writing a put option generates income immediately, but could create a loss later on (as could buying shares).

The investor writes one put option with a strike price of $32.50, expiring in three months, for $5.50. Therefore, the maximum gain is limited to $550 ($5.50 x 100 shares). The maximum loss is $2,700, or ($32.50 - $5.50) x 100 shares. The maximum loss occurs if the underlying falls to zero and the put writer needs to still buy the shares at $32.50. The loss is partially offset by the premium received.

RELATED TERMS
  1. Long Put

    A long put is buying a put option, which profits if the underlying ...
  2. Writer

    A writer is the seller of an option who collects the premium ...
  3. Currency Option

    A contract that grants the holder the right, but not the obligation, ...
  4. Put On A Put

    One of the four types of compound options, this is a put option ...
  5. Vanilla Option

    A vanilla option gives the holder the right to buy or sell an ...
  6. Protective Put

    A protective put is a risk-management strategy that investors ...
Related Articles
  1. Trading

    Beginners Guide To Options Strategies

    Find out four simple ways to profit from call and put options strategies.
  2. Trading

    Option trading strategies: A guide for beginners

    Options offer alternative strategies for investors to profit from trading underlying securities. Learn about the four basic option strategies for beginners.
  3. 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.
  4. Investing

    Why Options Trading Is Not for the Faint of Heart

    Trading options is not easy and should only be done under the guidance of a professional.
  5. Investing

    Is it Risky to Invest in Options?

    Investing with options can be a great strategy, but you need to do your research first or the risks can outweigh the benefits.
  6. Investing

    Long on Oil? Hedge Falling Oil Prices with Options

    With no end to the oil slump in sight, here are some risk management strategies using options to protect your oil positions.
RELATED FAQS
  1. When is a put option considered to be 'in the money?'

    Learn about put options, how these financial derivatives work, and when put options are considered to be in the money related ... Read Answer >>
  2. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  3. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  4. How do you use put options to profit from a bear market?

    Learn how traders use put options in their trading strategies to remain profitable, even in a bear market. Everyday investors ... Read Answer >>
Trading Center