What is a short put?
When you sell a put option without owning the underlying stock, you are initiating a short put position. This means that you will receive a credit when the trade is initiated. The credit is called the premium.
Selling a naked put option is a way to make money if the stock price goes down. When you sell an option, you are taking on the risk that the stock price might go up and you will have to buy the stock at a higher price. This is different from buying shares of stock, where you would lose money if the stock price goes up.
When to use a short put strategy
When someone sells a short put, they believe the price of the underlying asset will be higher than the strike price by the expiration date. They also believe that implied volatility will decrease, meaning that the option prices will be lower.
A short put strategy can also be useful for traders who want to buy the stock later on. When you sell a put option, you receive a credit, and you can use the proceeds to subsequently enter a long position. In the event the option is ever assigned to you, your cost basis for buying the stock will be lower.
How to manage a short put position
It is important to appreciate that time decay is a critical component of trading a short put profitably. You want the price of the option you sold to approach zero, because if you choose to close your position prior to expiration, it will be less expensive to buy it back.
After you enter a short put strategy, you want implied volatility to decrease. This will lower the price of the option you sold. If you choose to close your position prior to expiration, it will be less expensive to do so.
Short put maximum profit potential
The maximum profit for a short put is the amount of money you receive when you sell the put.
Short put maximum loss potential
The maximum loss from a short put trade that goes wrong is a significant amount of money. But it is limited to the strike price of the option minus what you got paid for selling the option.