Covered Put

Trading can be a wild ride, full of ups and downs, twists and turns. But what if there was a way to profit from a stock's downward trajectory while still leaving the door open for some upside potential? Enter the covered put, a trading strategy that's equal parts clever and intriguing.

What is a Covered Put?

A covered put is an options trading strategy where you sell (or "write") a put option while simultaneously owning the underlying stock. In other words, you're obligating yourself to buy the stock at a predetermined price (the strike price) if the option is exercised by the buyer.

Now, you might be thinking, "But wait, doesn't selling a put mean I'm betting on the stock going down?" And you'd be right – sort of. The beauty of the covered put is that it allows you to profit from a stock's decline while also benefiting from its potential upside.

How Does It Work?

Let's break it down with an example:

Say you own 100 shares of XYZ Corp. trading at $50 per share. You believe the stock might take a breather in the near future, so you decide to sell a put option with a strike price of $45 and receive a premium of $2 per share (or $200 total).

If XYZ stays above $45 by the time the option expires, you simply keep the $200 premium – easy money! But if XYZ drops below $45, the put option will likely be exercised, and you'll be obligated to buy an additional 100 shares at $45 per share.

Now, here's where the "covered" part comes into play: since you already own 100 shares, you're essentially just lowering your cost basis on those shares by the premium you received. So, if XYZ drops to $40, your actual cost per share would be $43 ($45 strike price minus $2 premium).

Why Use a Covered Put?

• Income Generation: By selling put options, you collect premiums upfront, providing a nice income stream.
• Potential Upside: If the stock rises, you still benefit from the increase in share value.
• Lower Cost Basis: If the stock drops and you're assigned shares, your cost basis is reduced by the premium received.
• Risk Management: Since you're already long the stock, your downside risk is limited to the stock's potential decline.

Of course, like any trading strategy, the covered put isn't without its risks. If the stock tanks, you'll be stuck holding even more shares at a higher cost basis. But for traders who are bullish on a stock long-term and don't mind potentially acquiring more shares at a discount, the covered put can be a powerful tool.

So, the next time you're feeling a bit bearish on a stock but still believe in its long-term potential, consider the covered put. It just might be the perfect way to have your bear market and profit from it too.