Accepting Exposure   • 213
Downside: Overvalued
Upside: Fairly valued
Execute: Sell a put contract
Risk: Strike price minus premium received [same as stock inves-
tor at the effective buy price (EBP)]
Reward: Limited to premium received
Margin: Notional amount of position
The Gist
The market is pricing in a relatively high probability that the stock price 
will fall. An investor, from a longer investment time frame perspective, 
believes that the value of the stock is likely worth at least the present mar-
ket value and perhaps more. The investor agrees to accept the downside 
risk perceived by the market and, in return, receives a premium for doing 
so. The premium cannot be fully realized unless the option expires out-  
of-the money (OTM). If the option expires in-the-money (ITM), the 
investor pays an amount equal to the strike price for the stock but can 
partially offset the cost of the stock by the premium received. The inves-
tor thus promises to buy the stock in question at a price of the strike 
price of the option less the premium received—what I call the effective 
buy price.
I think of the short-put strategy as being very similar to buying cor -
porate bonds and believe that the two investment strategies share many 
similarities. A bond investor is essentially looking to receive a specific 
monetary return (in the form of interest) in exchange for accepting 
the risk of the business failing. The only time a bond investor owns a 
company’s assets is after the value of the firm’s equity drops to zero, and 
the assets revert to the control of the creditors. Similarly, a short-put in-
vestor is looking to receive a specific monetary return (in the form of an 
option premium) in exchange for accepting the risk that the company’s 
stock will decrease in value. The only time a short-put investor owns a 
company’s shares is after the market value of the shares expires below the 
preagreed strike price.
Because the strategies are conceptually similar, I usually think of short-
put exposure in similar terms and compare the “yield” I am generating