Explanation

The covered put strategy is a bearish options strategy. The strategy involves shorting underlying stock in the expectation that the price of the security to fall and simultaneously selling a put option for some short-term profits. This strategy is exactly the opposite and works the same way as the Covered Call strategy, except that trader writes an option against a short position. The strategy typically makes sense when you have a neutral to slightly bearish sentiment and wants to take advantage of the price fall in the near future.

Risk

The risk is limitless in implementing this strategy.

Reward

The maximum reward in this strategy is limited to the premium received.

Construction

Sell 1 lot of Bank Nifty

Sell 1 NIFTY OTM Put Option

Payoff Chart

Option Trading Example

Suppose Bank Nifty is trading at 39600 levels, the trader is neutral or moderately bearish and expects the Bank Nifty to fall. He shorts 1 Bank Nifty Futures @ 40000 and simultaneously writes one 37500 out of the money (OTM) Put Option for a premium of Rs 180.

Scenario 1:

On expiry, if Bank Nifty closes at 39000 levels, then the trader will make a profit of

Profit = gain on short futures position + gain on premium received

Rs. 47120 = [(+40000 - 39000) + (178) *40]

Scenario 2:

On expiry, if Bank Nifty closes at 37300 levels, then the trader will make a loss of

Profit = Profit on futures position + Loss on premium received

Scenario 3:

On expiry, if Bank Nifty closes at 40500 levels, then the trader will make a loss of

Loss = loss on short futures + gain of premium received

12880 = ((-40500 + 40000) + (178)) *40