4.1.1.4. Short Put
Recall that a short put obligates the writer to buy shares at a certain strike price. The writer of a short put wishes to receive income and expects the price to go up and is willing to take some risk that the price may decline. Returning to our put example, if an investor shorts a Salmonella Seafoods put, she will receive a $1.50 premium. If at expiration the stock price has risen above the strike price of $20, the option will expire worthless, and the option writer will pocket her premium of $150 (1 put x 100 shares x $1.50). The $150 premium is the most the option writer stands to gain from writing the option. If the price of the underlying security drops below the strike price of $20, the option will be exercised, and the option writer will lose at least part of the premium she had received. Once the price of the underlying security falls below its breakeven of $18.50 ($20 – $1.50), the put writer will begin to lose money. How much she can lose is capped by the fact that the stock price cannot go below zero. Her losses per share will be capped at the strike price minus the premium that she receives. In this case, ($20 – $1.50) x 100 shares = $1,850.
There are three potential outcomes for the writer of a short put:
- 1. The stock price rises above or remains equal to the strike price. The option expires worthless and the writer keeps the entire premium.
- 2. The stock price falls below the strike price but stays above the breakeven price. The option writer loses part of the premium and keeps the rest.
- 3. The stock price falls below the breakeven price. The option writer loses money. They may lose all or part of their premium and they may be obligated to buy potentially worthless shares at the strike price.
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SUMMARY TABLE |
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Maximum Gain |
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