Covered Put
The last position in the family of basic volatility-selling strategies is the
covered put, sometimes referred to as selling puts and stock. In a covered
put, a trader sells both puts and stock on a one-to-one basis. The term
covered put is a bit of a misnomer, as the strategy changes from limited risk
to unlimited risk when short stock is added to the short put. A naked put can
produce only losses until the stock goes to zero—still a substantial loss.
Adding short stock means that above the strike gains on the put are limited,
while losses on the stock are unlimited. The covered put functions very
much like a naked call. In fact, they are synthetically equal. This concept
will be addressed further in the next chapter.
Let’s looks at another trader, Libby. Libby is an active trader who trades
several positions at once. Libby believes the overall market is in a range
and will continue as such over the next few weeks. She currently holds a
short stock position of 1,000 shares in Harley-Davidson. She is becoming
more neutral on the stock and would consider buying in her short if the
market dipped. She may consider entering into a covered-put position.
There is one caveat: Libby is leaving for a cruise in two weeks and does not
want to carry any positions while she is away. She decides she will sell the
covered put and actively manage the trade until her vacation. Libby will sell
10 Harley-Davidson March (22-day) 70 puts at 1.85 against her short 1,000
shares of Harley-Davidson, which is trading at $69 per share.
She knows that her maximum profit if the stock declines and assignment
occurs will be $850. That’s 0.85 × $100 × 10 contracts. Win or lose, she
will close the position in two weeks when there are only eight days until
expiration. To trade this covered put she needs to watch her greeks.
Exhibit 5.10 shows the greeks for the Harley-Davidson 70-strike covered
put.
EXHIBIT 5.10 Greeks for Harley-Davidson covered put (per contract).
Delta −0.419
Gamma−0.106
Theta 0.031
Vega −0.066