What are covered puts?

What are covered puts?

A covered put is created when put options are sold that correlates with a short stock position already being held or opened as a sell/write at one time. The stock position acts as a hedge for the short puts to limit losses as the short shares can be used if the put buyer wants to execute the contract at the strike price. Covered puts are the inverse of covered calls, as the underlying stock position is short versus long, and the option sold on the position is a put instead of a call.

A covered put option trader usually has a neutral to lightly bearish sentiment on price action inside the time frame of the put option until expiration. Selling covered puts on a short stock position creates the obligation to allow the stock to be sold at the strike price of the put option by the expiration date of the put.

A covered put already holds the stock position needed to fulfill this scenario so the short option risk is capped to the difference between the put premium and the exercise price. The risk is in the short equity position moving higher against the trader and the need to buy back the shares of the short stock position to cover at a higher price.

This position becomes unprofitable when the short stock goes higher than the short put premium received. The maximum reward would be that the stock stays at the same price and the covered put seller keeps the entire premium as profits when it expires out-of-the-money and the short stock position doesn’t move higher against them.

For an option play to be considered a covered put the trader needs to sell puts on the underlier at the same time a short stock position is opened using a sell/write with their broker or puts can be sold for premium on an existing short position planning on being held until the puts expire. Note that each put contract is in increments of 100 shares so the trader would need 100 short shares minimum per put option contract sold to create covered puts.