The original column has been published (shortened) in Dutch on September 18 at Telegraaf's DFT.nl / Goeroes / Opties 2.0 – deel 8. Basis Optiestrategie; Short Put

__Basic options strategies__
In my previous article of September
7th, "Basic Option Strategies; Short Call", you read all about the
third basic option strategy, the Short Call.

Today I’m going to cover the fourth
basic option strategy: the Short Put

__Short Put (Selling a Put option)____Structure__

A Short Put consists of a single
leg; the Sale of a Put option.

__Application__

A Short Put becomes attractive when you
expect either a neutral movement and/or an increase in the price of the
underlying asset.

A Short Put can also be used to
lower the purchase price of shares.

__Investment__

With a Short Put you’ll initially
receive money. The investment amounts to the number of contracts that you sell
x the Put option price x the contract size. If you sell 4 Put options for 6.50,
then you’ll receive 4 * 6.50 * 100 = 2,600 Euros.

__Margin__

The Short Put strategy comes with a
margin obligation. This means that you aren’t free to spend the received investment
and that you must maintain a specific margin as security (to offset potential
future losses) in addition. The Margin obligation is calculated and settled on
a daily basis. And also intraday for the various banks and brokers.

__Break-Even Point__

You’ll reach the break-even point
upon expiration if the price of the underlying asset is equal to the strike
price minus the price that you received for the Put option. The Put option now
has only an intrinsic and no longer a time value. Which is why your result is
0.

__Profit__

You’ll make a profit upon expiration
if the price of the underlying asset is above the break-even point.

__Maximum Profit__

The maximum profit that can be
achieved using a Short Put is limited to the Put Option premium received. Upon
expiration, the Put has a value equal to the strike price, minus the price of
the underlying asset. If upon expiration, the price of the underlying asset is
higher than the strike price of the Put option, then the Put option has no
remaining intrinsic value. The Put option will expire at 0 and you’ll realise
the maximum profit.

__Loss__

You’ll make a loss upon expiration
if the price of the underlying asset is below the break-even point.

__Maximum Loss (Risk)__

Your maximum loss is equal to the
exercise price of the Put option minus the purchase price of the Put option (so
basically unlimited)! Thus the lower the price of the underlying asset, the
greater the value of the Put option. And the greater your loss.

__Price of the Underlying Asset (Delta) Influence__

Positive. A Short Put has a positive
Delta. A higher underlying asset price results in a lower Put option premium.

__Remaining Maturity (Theta) Influence__

Positive. Time works to your
advantage with a Short Put strategy, because the remaining time value of the
Put option reduces daily.

__Volatility (Vega) Influence__

Negative. A higher volatility
indicates a greater remaining time value for the Put option and thus a higher
Put option premium.

__Advantages__

The advantage of the Short Put is
that no price change is required to achieve a profit. For at-the-money and
out-of-the-money Put options, a consistent underlying asset price is sufficient
to achieve the maximum result.

__Disadvantages__

The downside of the Short Put is
that the maximum loss is “unlimited”.

__Example__

Suppose that we sell a Put option on
the AEX-index with a strike price of 335.00 for a price of EUR 6.50. The AEX
lists it at 335.77 at that moment in time

One Put option provides an investment
of -1 x 6.50 x 100 = - EUR 650.

The Put option premium includes a
time value of 6.50 (= 100%). Thus 6.50 – intrinsic (= max (0. 335.00 – 335.77))
= 6.50 – 0.0 = 6.50. So, upon expiration the AEX price may drop by 7.27 (from
335.77 to 328.50 = -2.2%) in order to reach the break-even point. If the price is
above 328.50 we would achieve a profit using this strategy. And if the price is
above 335.00 (= -0.2%), we would realise the maximum profit using this
strategy.

Upon expiration the outcome would be
as follows:

Short Put Graphical Simulation:

The x-axis shows the various price
levels of the underlying asset.

The y-axis displays the (expected)
result. The blue line indicates the expected result one month prior to
expiration. The red line shows the result upon expiration.

__Pitfalls__

The most common pitfall for private
investors using Short Puts is to wait too long to close the position and take
their profit or loss.

This
completes the 4 basic options strategies so far. It is conveniently summarised
in the table below:

Next we can combine these 4 basic
option strategies with a second leg. We do this by buying or selling other Call
or Put options. This results in an options strategy that consists of two legs.
We may also combine options with the buying or selling of the underlying asset.

**Options 2.0 ... Options Strategies with 2 legs**

In this article we’ve taken a look
at the fourth basic option strategy with a single leg; the Short Put. And we’ve
covered how to use it and what the advantages and disadvantages are.

In the next article we’re going to
make a start on basic option strategies with two legs; we’ll begin with Call
Spreads and continue onto Put Spreads, Straddles and Strangles.

*Herbert Robijn is founder and director of FINODEX (www.finodex.com). FINODEX develops innovative online investment tools for private equity and options investors. These cutting-edge tools allow investors to make a comprehensive market analysis, complex calculations and appropriate selections, at just the touch of a button.*