How to Write Covered Puts

A covered put strategy makes money in a flat or down market.

Options give you the right, but not the obligation, to buy (call option) or sell (put option) the underlying stock at a specific price, known as the strike price, before an expiration date. Writing or selling a covered put means that you sell a stock short, known as taking a short position, and then sell put option contracts--one contract per 100 shares--against the shorted stock. The money you receive for selling the put options is known as the premium. Selling covered put options allows traders to make extra money in markets that are flat or trending down.

Things You'll Need

• Trading account

Instructions

1. Sell a stock short. Sell stock in blocks of 100 shares. Sell stock only when you believe that the stock will trade flat (stay at the same price) or trend down. Most stocks can be sold short. Contact a broker if you are unsure about a particular stock or simply instruct your online brokerage's software program that you wish to sell short. If the stock cannot be sold short, the program will let you know.

2. Write one put contract for each 100 shares of stock you have shorted. Sell put contracts one or two strike prices above the price at which you short sold your stock (these are in-the-money options) or one or two strikes below the stock's price (out-of-the-money options). The strike price is the price at which you can be forced to buy back your short stock. You will receive a greater premium for in-the-money options, but, on expiration, you might be forced to buy your stock back at a loss.

   Make sure that the short sale price plus the put premium exceeds the put strike price. For example, if you sell short a stock at $11 a share and you write a put with a $12 strike price, the put premium must be greater than $1.00 because you can be forced to buy back the stock you sold for $12 per share.

3. Sell additional puts on the same stock if you are not forced to buy back your stock when the options expire. You can also short sell additional stock and repeat the process the following month. Stock options expire on the third Friday of each month, allowing you to write covered puts every month.

Tips & Warnings

• Take your time to study and understand stock markets and options before writing covered puts. The puts are considered covered because you have already sold the underlying stock which will be used to cover most of your losses should the market turn against you and go higher.

• Covered puts can make you money if the stock price trends slightly higher, but potential losses are theoretically limitless since the stock you short could go up in price indefinitely.

References

• Get122: Covered Puts
• The Options Guide: Covered Put
• Power Options: Selling Covered Puts