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Short Put

Posted on June 26, 2024June 27, 2024 by admin

Short Put overview

Selling a naked put option is a levered alternative to buying shares of stock. Selling single options is considered “naked” because there is no risk protection if the stock moves against the position.

Because options are levered instruments, each short put contract is equivalent to holding 100 shares of stock. Short put option positions are typically cash-secured, meaning the put option writer must have enough capital available in his or her account to cover the cost of 100 shares if stock is assigned.

Short Put market outlook

A short put is sold when the seller believes the price of the underlying asset will be above the strike price on or before the expiration date and/or implied volatility will decrease. The closer the strike price is to the underlying’s price, the more credit will be received.

Selling a put option can be used to enter a long position if the investor wishes to buy the underlying stock. Because selling options collects a premium, initiating a long position with a short put reduces the cost basis if the put is ultimately assigned to the option seller.

How to set up a Short Put

A short put position is initiated when a seller writes a put option contract. Put options are listed in an options chain and provide relevant information for every strike price and expiration available, including the bid and ask price. The credit received at trade entry is called the premium. Market participants consider multiple factors to assess the option premium’s value, including the strike price relative to the stock price, time until expiration, and volatility.

Short Put payoff diagram

The payoff diagram for a short put represents the risk involved with selling naked options. Profit potential is limited to the amount of credit received when the put is sold. The risk is undefined until the stock reaches $0.

For example, if a short put option with a strike price of $100 is sold for $5.00, the maximum profit potential is $500. The maximum loss is undefined below the break-even point. The strike price minus the premium collected equals the break-even price of $95. If the underlying stock price is below the break-even point at expiration, the position will result in a loss.

Image of short put payoff diagram showing max profit, max loss, and break-even points

Entering a Short Put

To enter a short put position, a sell-to-open (STO) order is sent to the broker. The order is either filled at the asking price (market order) or at the minimum price an investor is willing to receive (limit order). Once a put option is sold, cash is credited to the trading account.

Sell-to-open: $100 put

Because selling put options has considerable downside risk, the broker will typically require the account have enough money if the option is assigned. For example, if one put option is sold at the $100 strike price, the broker may require at least $10,000 of available funds in the account.

Exiting a Short Put

There are multiple ways to exit a short put position. Anytime before expiration, a buy-to-close (BTC) order can be entered, and the contract will be purchased at the market or limit price. The premium paid will be debited from the account. If the contract is purchased for more premium than initially collected, a loss is realized. If the contract is purchased for less premium than initially collected, a profit is realized.

The buyer of the long put contract can choose to exercise the option at any time, and the seller is obligated to buy 100 shares at the strike price. If the short put option is in-the-money (ITM) at expiration, the option will automatically be assigned to the option seller. If the stock price is above the strike price at expiration, the option is out-of-the-money (OTM). The contract will expire worthless, and the seller will keep the entire premium initially collected.

Time decay impact on a Short Put

Time remaining until expiration and implied volatility make up an option’s extrinsic value and impact the premium price. All else being equal, options contracts with more time until expiration have higher prices because there is more time for the underlying asset to experience price movement. As time until expiration decreases, the option price goes down. Therefore, time decay, or theta, works in favor of put option sellers because an option’s value will decrease as expiration approaches.

Implied volatility impact on a Short Put

Implied volatility reflects the possibility of future price movements. Higher implied volatility results in higher option prices because there is an expectation the price may move more than expected in the future. As implied volatility decreases, a put option contract will lose value and the seller may purchase the contract for less money than it was sold. Options sellers benefit when implied volatility decreases before expiration.

Adjusting a Short Put

Short put positions can be managed during a trade. A single-leg short put option can be adjusted to minimize risk.

If the position is challenged, a put option can be purchased at a lower strike price to convert the short put into a bull put credit spread. The long option defines the position’s risk, but lowers the profit potential to the width of the spread minus the credit received.

For example, if a $100 put option is sold, a $90 put option can be purchased. If the long put costs $2.00, the max profit potential is reduced to $3.00. However, the maximum risk is defined at $700 if the underlying asset is below $90 at expiration.

Buy-to-open: $90 put

Image of a short put adjusted to a bull put credit spread

Rolling a Short Put

If an investor wants to extend the trade, the short put option can be rolled out to a future expiration date. Rolling out the option requires buying-to-close (BTC) the short put and selling-to-open (STO) a new put option with the same strike price for a future date. Rolling the option should result in additional credit, which will widen the break-even price and increase the profit potential relative to the original position. The risk will be reduced by the amount of credit received but is still undefined.

For example, if a short put with a $100 strike price has a May expiration date, the position could closed and reopened with a June expiration date. If the adjustment receives $2.00 of premium, the break-even point is extended to $93.

Short put roll out to later expiration date for credit

Hedging a Short Put

To hedge a short put, an investor may sell a call with the same strike price and expiration date, thereby creating a short straddle. This will add additional credit and extend the break-even price above and below the centered strike price of the short straddle equal to the amount of premium collected. While this reduces cost basis, the risk is still undefined and potentially substantial.

For example, if the position is challenged, a call with a $100 strike price could be sold. If an additional $5.00 of credit is received, the max profit increases to $1,000 and the break-even price moves down to $90.

Sell-to-open: $100 call

Image of short put adjusted to a short straddle

Synthetic Short Put

A synthetic short put combines long stock with a short call option at the strike price of the original long stock position. This creates a synthetic short put because the payoff diagram is similar to a single short put option. As with a naked short put, the expectation is price will rise before expiration.

Selling the call will collect a premium, but the risk beyond the premium received is still unlimited if the stock continues to fall. The maximum profit potential is limited to the premium collected for the short call. If the stock closes above the strike price at expiration, the long stock will be covered when the short call is exercised, and the shares will offset.

FAQs

What is a short put option?

A short put is a bullish options strategy with undefined risk and limited profit potential. You receive a credit when opening a naked short put, which lowers your cost basis.

Is a short put bullish?

Yes, short put options are bullish. You will profit if the underlying stock’s price is above the short put strike at expiration.

Can I exit a short put before expiration?

Yes, you can exit a short put at any time by buying back the option. If you buy the options for less than you sold it, you’ll realize a profit of the difference. Short puts are typically profitable when the underlying stock’s price increases and/or volatility decreases.

How to hedge a short put option?

There are multiple ways to hedge a short put option. You can sell a short call to create a short straddle or short strangle. You could also buy an out-of-the-money long put option to create a risk-defined short put spread.

What is an example of a short put?

You sell a short put when you’re bullish and believe the stock will stay above a certain price.

For example, if you think AAPL will be above $140 in two months, you could sell a put with a $140 strike price 60 days to expiration.

Short Call

Posted on June 26, 2024June 27, 2024 by admin

Short Call overview

Selling a naked call option is a levered alternative to short selling stock. Selling single options is considered “naked” because there is no risk protection if the stock moves against the position.

Because options are levered instruments, each short call contract is equivalent to selling 100 shares of stock. Naked call options require margin to protect against large price increases in the underlying asset.

Short Call market outlook

A short call is sold when the seller believes the price of the underlying asset will be below the strike price on or before the expiration date and implied volatility will decrease. The closer the strike price is to the underlying’s price, the more credit will be received.

Selling a call option can be used to enter a short position if the investor wishes to sell the underlying stock. Because selling options collects a premium, initiating a short position with a short call reduces the cost basis if the call option is ultimately assigned to the option seller.

How to set up a Short Call

A short call position is initiated when a seller writes a call option contract. Call options are listed in an options chain and provide relevant information for every strike price and expiration available, including the bid and ask price. The credit received at trade entry is called the premium. Market participants consider multiple factors to assess the option premium’s value, including the strike price relative to the stock price, time until expiration, and volatility.

Short Call payoff diagram

The payoff diagram for a short call represents the risk involved with selling naked options. Profit potential is limited to the amount of credit received when the call is sold. However, the risk is unlimited if the underlying asset experiences an increase in price.

For example, if a short call option with a strike price of $100 is sold for $5.00, the maximum profit potential is $500. The maximum loss is undefined above the break-even point. The strike price plus the premium collected equals the break-even price of $105. If the underlying stock price is above the break-even point at expiration, the position will result in a loss.

Short call payoff diagram showing max profit, max loss, and break-even point

Entering a Short Call

To enter a short call position, a sell-to-open (STO) order is sent to the broker. The order is either filled at the asking price (market order) or at the minimum price an investor is willing to recieve (limit order). Once a call option is sold, cash is credited to the trading account.

Sell-to-open: $100 call

Because selling call options has significant undefined risk, the broker will hold margin against the account to cover potential losses. The margin amount depends on the broker, the stock’s price, and market volatility. Margin is not static and may increase or decrease as volatility fluctuates. The higher the volatility, the more margin required to hold the short call position.

Exiting a Short Call

There are multiple ways to exit a short call position. Anytime before expiration, a buy-to-close (BTC) order can be entered, and the contract will be purchased at the market or limit price. The premium paid will be debited from the account. If the contract is purchased for more premium than initially collected, a loss is realized. If the contract is purchased for less premium than initially collected, a profit is realized.

The buyer of the long call contract can choose to exercise the option at any time, and the seller is obligated to sell 100 shares at the strike price. If the short call option is in-the-money (ITM) at expiration, the option will automatically be assigned to the option seller. If the stock price is below the strike price at expiration, the option is out-of-the-money (OTM). The contract will expire worthless, and the seller will keep the entire premium initially collected.

Time decay impact on a Short Call

Time remaining until expiration and implied volatility make up an option’s extrinsic value and impact the premium price. All else being equal, options contracts with more time until expiration have higher prices because there is more time for the underlying asset to experience price movement. As time until expiration decreases, the option price goes down. Therefore, time decay, or theta, works in favor of call option sellers because an option’s value will decrease as expiration approaches.

Implied volatility impact on a Short Call

Implied volatility reflects the possibility of future price movements. Higher implied volatility results in higher option prices because there is an expectation the price may move more than expected in the future. As implied volatility decreases, a call option contract will lose value and the seller may purchase the contract for less money than it was sold. Options sellers benefit when implied volatility decreases before expiration.

Adjusting a Short Call

Short call positions can be managed during a trade. A single-leg short call option can be adjusted to minimize risk.

If the position is challenged, a call option can be purchased at a higher strike price to convert the short call into a bear call credit spread. The long option defines the position’s risk, but lowers the profit potential to the width of the spread minus the credit received.

For example, if a $100 call option is sold, a $110 call option can be purchased. If the long call costs $2.00, the max profit potential is reduced to $3.00. However, the maximum risk is defined at $700 if the underlying asset is above $110 at expiration.

Buy-to-open: $110 call

Image of a short call adjusted to a bear call credit spread

Rolling a Short Call

If an investor wants to extend the trade, the short call option can be rolled out to a future expiration date. Rolling out the option requires buying-to-close (BTC) the short call and selling-to-open (STO) a new call option with the same strike price for a future date. Rolling the option should result in additional credit, which will widen the break-even price and increase the profit potential relative to the original position. The risk will be reduced by the amount of credit received but is still undefined.

For example, if a short call with a $100 strike price has a May expiration date, the position could closed and reopened with a June expiration date. If the adjustment receives $2.00 of premium, the break-even point is extended to $107.

Short call roll out to later expiration date for credit

Hedging a Short Call

To hedge a short call, an investor may sell a put with the same strike price and expiration date, thereby creating a short straddle. This will add additional credit and extend the break-even price above and below the centered strike price of the short straddle, equal to the amount of premium collected. While this increases the premium received, the risk is still undefined and potentially substantial.

For example, if the position is challenged, a put with a $100 strike price could be sold. If an additional $5.00 of credit is received, the max profit increases to $1,000 and the break-even price moves up to $110.

Sell-to-open: $100 put

Image of short call adjusted to a short straddle

Synthetic Short Call

A synthetic short call combines short stock with a short put option at the strike price of the original short stock position. This creates a synthetic short call because the payoff diagram is similar to a single short call option. As with a naked short call, the expectation is that the underlying price will decline before expiration.

Selling the put will collect a premium, but the risk beyond the premium received is still unlimited if the stock continues to rise. The maximum profit potential is limited to the premium collected for the short put. If the stock closes below the strike price at expiration, the short stock will be covered when the short put is exercised, and the shares will offset.

FAQs

What is a short call option?

Short call options are a single-leg bearish strategy with undefined risk. Traders typically use short call options when they believe the underlying stock price will decline and/or volatility will decrease.

How does a short call option work?

Call option buyers have the right to exercise their option at any time and buy shares of stock at the option’s strike price. When you sell a call option, you are required to sell the underlying stock if your option is assigned.

Are call options bullish or bearish?

Short call options are bearish. The position will profit if the underlying stock price is below the strike price at expiration.

Long call options are bullish. To realize a profit, the stock price must be above the strike price by at least the option’s cost.

Can I close a call option before expiration?

Yes, you can close a call option any time before expiration. If you sold a short call, you can buy back the option to exit the trade.

What’s better: short call options or long put options?

Short calls and long puts are both bearish strategies. However, they have different risk/reward profiles. Long put options have defined risk and unlimited profit potential. They work best when volatility increases. Conversely, short call options have unlimited risk, limited profit potential, and work best when volatility declines.

Long Put

Posted on June 26, 2024June 27, 2024 by admin

Long Put overview

Short selling stock is not available for all investors as it requires borrowing stock and uses margin. Furthermore, as opposed to buying a long put, short selling has unlimited risk because the underlying asset has unlimited upside potential.

Long put options give the buyer the right, but no obligation, to sell shares of the underlying asset at the strike price on or before expiration. Because options are levered investments, each contract is equivalent to selling 100 shares of stock. An advantage of using a long put option is that less capital is required to own one contract than the cost of selling 100 shares of stock, and downside risk is limited to the option contract’s cost.

Long Put market outlook

A long put is purchased when the buyer believes the price of the underlying asset will decline by at least the cost of the premium on or before the expiration date. Further out-of-the-money strike prices will be less expensive but have a lower probability of success. The further out-of-the-money the strike price, the more bearish the sentiment for the outlook of the underlying asset.

How to set up a Long Put

A long put position is initiated when a buyer purchases a put option contract. Puts are listed in an option chain and provide relevant information for every strike price and expiration available, including the bid-ask price. The cost to enter the trade is called the premium. Market participants consider multiple factors to assess the value of an option’s premium, including the strike price relative to the stock price, time until expiration, and volatility.

Typically, put options are more expensive than their call option counterparts. This pricing skew exists because investors are willing to pay a higher premium to protect against downside risk when hedging positions.

Long Put payoff diagram

The payoff diagram for a long put is straightforward. The maximum risk is limited to the cost of the option. The profit potential is unlimited until the underlying asset reaches $0. To break even on the trade at expiration, the stock price must be below the strike price by the cost of the long put option.
For example, if a long put option with a $100 strike price is purchased for $5.00, the maximum loss is defined at $500, and the profit potential is unlimited until the stock reaches $0. However, the underlying stock must be below $95 at expiration to realize a profit.

Image of long put payoff diagram showing max profit, max loss, and break-even points

Entering a Long Put

To enter a long put position, a buy-to-open (BTO) order is sent to the broker. The order is either filled at the asking price (market order) or at a specific price an investor is willing to pay (limit order). The call option purchase results in cash debited from the trading account.

Buy-to-open: $100 put

Exiting a Long Put

There are multiple ways to exit a long put position. Anytime prior to expiration, a sell-to-close (STC) order can be entered, and the contract will be sold at the market or a limit price. The premium collected from the sale will be credited to the account.

If the contract is sold for more premium than originally paid, a profit is realized. If the contract is sold for less premium than originally paid, a loss is realized.

If the long put option is in-the-money (ITM) at expiration, the holder of the contract can choose to exercise the option and will sell 100 shares of stock at the strike price. If the long put option is out-of-the-money (OTM) at expiration, the contract will expire worthless and the full loss is realized.

Time decay impact on a Long Put

Time remaining until expiration and implied volatility make up an option’s extrinsic value and impact the premium price. All else being equal, options contracts with more time until expiration will have higher prices because there is more time for the underlying asset to experience price movement. As time until expiration decreases, the option price goes down. Therefore, time decay, or theta, works against options buyers.

Implied volatility impact on a Long Put

Implied volatility reflects the possibility of future price movements. Higher implied volatility results in higher priced options because there is an expectation the price may move more than expected in the future. As implied volatility decreases, the option price goes down. Options buyers benefit when implied volatility increases before expiration.

Adjusting a Long Put

Long put positions can be managed during a trade to minimize loss. A single-leg long put option can be converted into a bear put debit spread.

If the stock price increases, a put option can be sold at a lower strike price to reduce the trade’s risk. This decreases the overall cost of the original position and lowers the break-even price. However, the short put option limits the maximum profit potential to the spread width minus the debit paid.

For example, if a $100 put option was purchased for $5.00, a $95 put option could be sold. If the short put option collects $1.00 of credit, the maximum loss is reduced to $400. The max profit, however, is now capped at $100 if the stock reverses and closes below $95 at expiration. The break-even point is now $1.00 less than the original payoff diagram.

Sell-to-open: $95 put

Image of a long put option adjusted to a bear put debit spread

Rolling a Long Put

Long put positions can be adjusted to extend the time duration of the trade if the stock has not decreased before expiration. The ability to roll the position into the future allows the trade more time to become profitable, but will come at a cost because more time equates to higher options prices.

If an investor wants to extend the trade, the long put option can be rolled out by selling-to-close (STC) the current position and buying-to-open (BTO) an option at a future date. This will likely result in paying a debit and will add cost to the original position.

For example, a $100 put option with a November expiration date could be sold and a $100 put option could be purchased for December. If the original position cost $5.00, and was sold for $2.00, the net loss on the original position is $300 per contract. If the December option costs an additional $5.00, the overall debit of the position is now $8.00. Therefore, the max loss increases to $800 and the break-even point moves out to $92.

Payoff diagram of a long put roll out for a debit

Hedging a Long Put

To hedge a long put, an investor may purchase a call with the same strike price and expiration date, thereby creating a long straddle. If the underlying stock price increases above the strike price, the call will experience a gain in value and help offset the loss of the long put. However, this adds cost to the original trade and widens the break-even price.

For example, if the original long put had a $5.00 debit, and a long call is purchased for an additional $5.00, the risk increases to $1,000 and the break-even points are extended.

Buy-to-open: $100 call

Long put converted to a long straddle to hedge price action

Synthetic Long Put

A synthetic long put combines short stock with a long call option at the strike price of the original short stock position. This creates a synthetic long put because the payoff diagram is similar to a single long put option. The maximum downside risk is limited to the strike price of the long call option, and the profit potential is limited to the difference between the sale price of the short stock position and the call option premium paid.

FAQs

What is a put option?

A long put is a bearish options strategy with defined risk and unlimited profit potential. Buying a put option is an alternative to shorting stock. Unlike short selling a stock, which has unlimited risk, a put option’s maximum risk is limited to the its premium.

Long put options give the buyer the right to sell shares of the underlying stock at the strike price on or before expiration.

How do put options work?

Buying a put option contract gives you the right, but no obligation, to sell shares at the contract’s strike price. Writing a put option obligates you to buy shares at the cotract’s strike price. If you are long a put option, you are bearish on the underlying security.

How to calculate put option profit?

Long puts have unlimited profit potential. A long put option must be below its break even price at expiration to realize a profit. To calculate a long put’s break even price, subtract the contract’s premium from the option’s strike price. The option’s cost is the max loss for the position.

Long Call

Posted on June 25, 2024June 27, 2024 by admin

Long Call overview

Long call options give the buyer the right, but no obligation, to purchase shares of the underlying asset at the strike price on or before expiration. Because options are levered investments, each contract is equivalent to holding 100 shares of stock. An advantage of using a long call option is that less capital is required to own one contract compared to the cost of owning 100 shares of stock, and downside risk is limited to the option contract’s cost.

Long Call market outlook

A long call is purchased when the buyer believes the price of the underlying asset will increase by at least the cost of the premium on or before the expiration date. Further out-of-the-money strike prices will be less expensive but have a lower probability of success. The further out-of-the-money the strike price, the more bullish the sentiment for the outlook of the underlying asset.

How to set up a Long Call

A long call position is initiated when a buyer purchases a call option contract. Calls are listed in an option chain and provide relevant information for every strike price and expiration available, including the bid-ask price. The cost to enter the trade is called the premium. Market participants consider multiple factors to assess the value of an option’s premium, including the strike price relative to the stock price, time until expiration, and volatility.

Long Call payoff diagram

The payoff diagram for a long call is straightforward. The maximum risk is limited to the cost of the option. The profit potential is unlimited. To break even on the trade at expiration, the stock price must exceed the strike price by the cost of the long call option.

For example, if a long call option with a $100 strike price is purchased for $5.00, the maximum loss is defined at $500 and the profit potential is unlimited if the stock continues to rise. However, the underlying stock must be above $105 at expiration to realize a profit.

Entering a Long Call

To enter a long call position, a buy-to-open (BTO) order is sent to the broker. The order is either filled at the asking price (market order) or at a specific price an investor is willing to pay (limit order). The call option purchase results in cash debited from the trading account.

Buy-to-open: $100 call

Exiting a Long Call

There are multiple ways to exit a long call position. Anytime before expiration, a sell-to-close (STC) order can be entered, and the contract will be sold at the market or a limit price. The premium collected will be credited to the account.

If the contract is sold for more premium than originally paid, a profit is realized. If the contract is sold for less premium than originally paid, a loss is realized.

If the long call option is in-the-money (ITM) at expiration, the holder of the contract can choose to exercise the option and will receive 100 shares of stock at the strike price. If the long call option is out-of-the-money (OTM) at expiration, the contract will expire worthless and the full loss is realized.

Time decay impact on a Long Call

Time remaining until expiration and implied volatility make up an option’s extrinsic value and impact the premium price. All else being equal, options contracts with more time until expiration will have higher prices because there is more time for the underlying asset to experience price movement. As time until expiration decreases, the option price goes down. Therefore, time decay, or theta, works against options buyers.

Implied volatility impact on a Long Call

Adjusting a Long Call

Long call positions can be managed during a trade to minimize loss. A single-leg long call option can converted into a bull call debit spread.

If the stock price declines, a call option can be sold at a higher strike price to reduce the trade’s risk. This decreases the overall cost of the original position and lowers the break-even price. However, the short call option limits the maximum profit potential to the spread width minus the debit paid.

For example, if a $100 call option was purchased for $5.00, a $105 call option could be sold. If the short call option collects $1.00 of credit, the maximum loss is reduced to -$400. The max profit, however, is now capped at $100 if the stock reverses and closes above $105 at expiration. The break-even point is now $1.00 less than the original payoff diagram.

Sell-to-open: $105 call

Rolling a Long Call

Long call positions can be adjusted to extend the time duration of the trade if the stock has not increased before expiration. The ability to roll the position into the future allows the trade more time to become profitable, but will come at a cost because more time equates to higher options prices.

If an investor wants to extend the trade, the long call option can be rolled out by selling-to-close (STC) the current position and buying-to-open (BTO) an option at a future date. This will likely result in paying a debit and will add cost to the original position.

For example, a $100 call option with a November expiration date could be sold and a $100 call option could be purchased for December. If the original position cost $5.00, and was sold for $2.00, the net loss on the original position is -$300 per contract. If the December option costs an additional $5.00, the overall debit of the position is now $8.00. Therefore, the max loss increases to -$800 and the break-even point moves out to $108.

Hedging a Long Call

To hedge a long call, an investor may purchase a put with the same strike price and expiration date, thereby creating a long straddle. If the underlying stock price falls below the strike price, the put will experience a gain in value and help offset the loss of the long call. However, this adds cost to the original trade and widens the break-even price.

For example, if the original long call had a $5.00 debit, and a long put is purchased for an additional $5.00, the risk increases to $1,000 and the break-even points are extended.

For example, a $100 call option with a November expiration date could be sold and a $100 call option could be purchased for December. If the original position cost $5.00, and was sold for $2.00, the net loss on the original position is -$300 per contract. If the December option costs an additional $5.00, the overall debit of the position is now $8.00. Therefore, the max loss increases to -$800 and the break-even point moves out to $108.

Sell-to-open: $105 call

Synthetic Long Call

A synthetic long call combines long stock with a long put option at the entry price of the original long stock position. This creates a synthetic long call because the payoff diagram is similar to a single long call option. The maximum downside risk is limited to the long put option’s strike price, and the profit potential is unlimited if the stock continues to rise.

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