What are the characteristics of this option strategy?
Short put positions involve selling a put option with a strike price lower than the price of the underlying stock or asset. In this strategy, you keep the premium received from the sale of the put as long as the stock stays above the strike price at expiration, and that premium is the most the trade can ever make. In exchange you take on the obligation to buy 100 shares at the strike, so a sharp fall in the stock costs far more than the premium collected.
Is this a bullish, bearish or neutral strategy?
The Short Put Option Strategy is a neutral-to-bullish strategy with limited profit (the premium received) and substantial downside risk: it obligates you to buy the stock at the strike, so a falling stock produces losses equivalent to owning 100 shares from the strike down, up to strike minus premium if the stock goes to zero. You benefit from the stock's price being held up, and you receive a premium in exchange for the obligation to buy the stock at the strike price if its price falls below that strike.
Is this a beginner or an advanced option strategy?
The Short Put Option Strategy is an advanced option strategy. It requires knowledge and understanding of the stock market and options trading.
In what situation will I use this strategy?
The Short Put Option Strategy is used when the outlook for the stock is neutral to bullish. Note that shares you already own do not cover a short put, they add to the same downside exposure. To generate income from stock you already own, use a covered call instead.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
This strategy pairs a high probability of a small gain with a low probability of a large loss. It wins more often than buying a call, because the stock only has to stay above the strike, but the reward-to-risk is far worse: the gain is fixed at the premium while the loss runs down with the stock. A bull put spread, which buys a lower strike put against the short one, gives up some of the premium to cap that downside.
How is this strategy affected by the greeks?
The greeks are used to measure the sensitivity of an option’s price to time decay, implied volatility, and the underlying stock’s price. In the Short Put Option Strategy, the delta and theta greeks are used to measure the impact of the passage of time and the stock’s price on the option’s value. The seller is long delta, long theta, short vega and short gamma, so decay works for the position while a fall in the stock or a rise in implied volatility works against it, and the delta gets heavier the further the stock drops.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Short Put Option Strategy is best used when implied volatility is elevated relative to expected realized volatility, and ideally falling. High implied volatility raises the put premium you collect for the same downside obligation, which widens your breakeven and improves the risk-reward.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
When the stock falls toward the strike, the usual adjustments are to buy the put back for a loss, to roll it down and out to a lower strike and a later expiration, or to buy a lower strike put against it, which caps the downside and turns the position into a defined-risk bull put spread. The mechanics are simple, but none of them are free: each one either pays out cash or gives up premium, and the last is the only one that puts a floor under the loss.
Where does this strategy typically fall in the range of commissions and fees?
Commissions are low, since this is a single contract to open and one to close. The larger cost is the margin the broker holds against the obligation to buy the shares, plus the assignment fee and the capital tied up if the put finishes in the money and the stock is put to you.
Is this a good option income strategy?
Yes, this strategy can be a good option income strategy, depending on the individual’s risk tolerance and preferences. The potential profit is limited to the premium received, while the potential loss is many times larger: it grows dollar-for-dollar as the stock falls below the strike, up to strike minus premium ($20,750 on the AAPL example below), so this position must be sized against that downside, not against the premium.
How do I know when to exit this strategy?
You should exit the strategy once the stock has gone significantly higher than the price at which the put was sold or when the time remaining before expiration is very small. It is important to set both a price target and a loss limit before the position is opened, such as buying the put back if it reaches two or three times the credit received, because nothing in the structure itself stops the loss as the stock falls.
How will market makers respond to this trade being opened?
Market makers will typically take the other side of the sale without difficulty, earning the bid-ask spread and hedging the resulting long put with the underlying rather than taking a directional view on the stock.
What is an example (with calculations) of this strategy?
For example, let’s say Apple (AAPL) is trading at $220 and you are willing to own it lower. You can sell an AAPL put option with a strike price of $210 and a 45-day expiration date at a price of $2.50. This would give you a total premium of $250, which is the maximum profit potential on this trade. If AAPL remains above $210 through expiration, you will keep the $250 premium. If AAPL drops below $210 you will be assigned and must buy 100 shares at $210. Your breakeven is $207.50 ($210 strike less the $2.50 premium); below that you lose ($210 - stock price) x 100 minus the $250 premium, which is $750 at $200, $2,750 at $180, and a maximum of $20,750 if AAPL went to zero.
MarketXLS
MarketXLS is an options trading software that can help traders with options strategies including the Short Put Options Strategy. It includes features such as stock and options scanners, historical back testing and more, allowing traders to easily track and analyze options prices and trends. With MarketXLS, traders can easily execute this strategy and monitor the performance of their trades. For more information on vertical and spread strategies, please refer to the Vertical Options Spread and Short Guts Long Guts Option Strategies.
Here are some templates that you can use to create your own models
Short Put Option Strategy
Diagonal Spread with Puts Option Strategy
Long Butterfly with Puts Option Strategy
Long Put Option Strategy
Put Ratio Back-Spread
Bear Put Spread Option Strategy
Bull Put Spread Option Strategy
Collar Option Strategy
Long Calendar Spread With Puts Option Strategy
Long Calendar Spread with Puts Option Strategy
Risk Reversal Option Strategy
Short Put Ladder
Short Straddle Option Strategy
Iron Butterfly Option Strategy
Short Strangle Option Strategy
Iron Condor Option Strategy
Short Gut
Synthetic Short Straddle with Puts
Butterfly for Shorts Spread
Conversion Strategy
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Short Put Option Strategy (With Excel Template)
Making Sense of Option Time Value
Maximizing Profits with a Bull Put Spread Strategy
Reverse Iron Butterfly Options Strategy (Using MarketXLS Template)
Short Put Ladder Options Strategy (Using Excel Template)