Writing a covered put option
Managing Risk with Options Strategies: Covered Calls and Protective Puts
The strategy gets its name from the reduced risk and capital requirement relative to a standard covered put. The strategy is also much safer than a covered put because there is no naked short stock component. The exact maximum profit potential cannot be calculated due to the differing expiration cycles used. However, the profit potential can be estimated with the following formula: Width of put strikes - net debit paid How to Calculate Breakeven s: The exact break-even cannot be calculated due to the differing expiration cycles used in the trade.
As a rough estimate, the break-even area can be approximated with the following formula: Long put strike price - net debit paid. This is because a covered put position incorporates shorting stock, which is a strategy with undefined risk. Trading a PMCP is a way to define the risk of the trade and use less capital. If we have a bad setup, we can actually set ourselves up to lose money if the trade moves in our direction too fast.
To ensure we have a good setup, we check the extrinsic value of our longer dated ITM option. Once we figure that value, we ensure that the near term option we sell is equal to or greater than that amount. The deeper ITM our long option is, the easier this setup is to obtain. Each expiration acts as its own underlying, so our max loss is not defined.
When do we close PMCPs? In the best case scenario, a PMCP will be closed for a winner if the stock prices decreases significantly in one expiration cycle.
This is because the put options will trade closer to intrinsic value and the profit potential for the trade will diminish. When do we manage PMCPs? For losing trades due to the stock price increasing, the short put can be rolled to a higher strike to collect more credit.
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Covered Put Writing
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Using Covered Calls and Covered Puts to Manage Risk
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