assigned, this is the effective purchase price of the stock. The obligation to
buy at $65 is fulfilled, but the $1.20 premium collected makes the purchase
effectively $63.80. Here, again, there is limited profit opportunity ($1.20 if
the stock is above the strike price) and seemingly unlimited risk (the risk of
potential stock ownership at $63.80) if Boeing is below the strike price.
Why would a trader short a put and willingly assume this substantial risk
with comparatively limited reward? There are a number of motivations that
may warrant the short put strategy. In this example, Sam had the twin goals
of profiting from a neutral to moderately bullish outlook on Boeing and
buying it if it traded below $65. The short put helps him achieve both
objectives.
Much like the covered call, if the stock is above the strike at expiration,
this trader reaches his maximum profit potential—in this case 1.20. And if
the price of Boeing is below the strike at expiration, Sam has ownership of
the stock from assignment. Here, a strike price that is lower than the current
stock level is used. The stock needs to decline in order for Sam to get
assigned and become long the stock. With this strategy, he was able to
establish a target price at which he would buy the stock. Why not use a limit
order? If the put is assigned, the effective purchase price is $63.80 even if
the stock price is above this price. If the put is not assigned, the premium is
kept.
A consideration every trader must make before entering the short put
position is how the purchase of the stock will be financed in the event the
put is assigned. Traders hoping to acquire the stock will often hold enough
cash in their trading account to secure the purchase of the stock. This is
called a cash-secured put . In this example, Sam would hold $6,380 in his
account in addition to the $120 of option premium received. This affords
him enough free capital to fund the $6,500 purchase of stock the short put
dictates. More speculative traders may be willing to buy the stock on
margin, in which case the trader will likely need around 50 percent of the
stock’s value.
Some traders sell puts without the intent of ever owning the stock. They
hope to profit from a low-volatility environment. Just as the short call is a
not-bullish stance on the underlying, the short put is a not-bearish play. As
long as the underlying is above the strike price at expiration, the option