Hi Friends. We will continue our series
on Option Strategies. Today we will take up a bearish strategy. So
without wasting any time let’s take up today’s strategy
This is a strategy which we can use when
we are neutral to bearish in the Market. We take up this strategy when
we feel the price of a stock or index is going to remain range bound
with changes to move down. In this strategy we short the stock to cover
the put that is written.
The Put that is sold is generally an OTM Put.
We short a stock because we are bearish
about it, but do not mind buying it back once the price falls to a
target price. This target price is the price at which the investor
shorts the Put (Put strike price). Selling a Put means, buying the stock
at the strike price if exercised.
When the stock drops, the investor will have the stock put to them at
the short put strike price. This covers the obligation of the shares of
stock that were shorted. The investor keeps the initial premium received
from selling the put. If the stock rises the investor keeps the
premium, but they are still holding the short stock obligation and could
sustain a loss to close the short.
When can we use this strategy??
When you think that the markets are moderately bearish.
Risk involved while using this strategy
Unlimited if the price of the stock rises substantially
Benefits of using the strategy
Maximum reward is (Sale Price of the Stock – Strike Price) + Put Premium
When do we achieve the break-even?
Sale Price of Stock + Put Premium
Let’s assume current stock price of XYZ Company is Rs. 4500
We short Rs 4300 Put by selling a next month Put for Rs. 24 while
shorting stock of XYZ company. The net credit received by us is Rs. 4500
+ Rs. 24 = Rs. 4524.
The Analysis of the Strategy
Covered puts enable traders to bring in
some extra premium on short positions. Once again, you can keep selling a
put against the short shares every month to increase your profit.
However, shorting stock is a risky trade no matter how you look at it
because there is no limit to how much you can lose if the price of the
stock rises above the break-even.