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Selling a Put is opposite of buying a Put. An investor buys Put when he is bearish on a stock. An investor Sells Put when he is bullish about the stock—i.e. he expects the stock price to rise or stay sideways at the minimum.
When you sell a Put, you earn a premium ( from the buyer of the Put). You have sold someone the right to sell you the stock at the strike price. If the stock price increases beyond the strike price, the short put position will make a profit for the seller by the amount of the premium because the buyer will not exercise the Put option and the Put seller can retain the Premium (which is her/his maximum profit). But, if the stock price decreases below the strike price, by more than the amount of the premium, then the Put seller will lose money. The potential loss being unlimited (until the stock price falls to zero).
When to Use: Investor is very bullish on the stock/index. The main idea is to make a short term income.
Risk: Put Strike Price—Put Premium
Reward: Limited to the amount of Premium received.
Breakeven: Put Strike Price—Premium
Mr. XYZ is feeling bullish on Nifty when it is at 4191.10. He sells a Put option with a strike price of Rs. 4100 at a premium of Rs. 170.50 expiring on July 31.
If the Nifty index stays above 4100, he will gain the amount of premium as the Put buyer won’t exercise his option.
In case the Nifty falls below 4100, Put buyer will exercise the option and Mr. XYZ will start losing money.
If the Nifty falls below 3929.50, which is the breakeven point, Mr.XYZ will lose the premium and more depending on the extent of the fall in Nifty.
Selling Puts can lead to a regular income in a rising or range bound market. But it should be done carefully because the potential losses can be significant in case the stock price/index falls.
This strategy can be considered as an income generating strategy.
To learn more about Trading Strategies visit Upstox Knowledge Base.