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