Sell A Put

A trader who thinks that a stock will go up can sell a put. When a trader sells a put he collects a premium. If the stock price is above the strike price by the expiration date, then the short put expires worthless and the seller keeps the premium. The premium collected is the seller’s profit. Otherwise, if the stock price is below the strike price by more than the amount collected in premium, then the seller would lose money.

This is also called a naked put. In practice, to sell naked options, a brokerage firm typically requires a seller to deposit funds (margin requirements) sufficient to cover a 2 standard deviation move in the stock price. This trade results in a net credit to the seller, but requires margin to be maintained in the seller’s account until expiration.

Example

Suppose MSFT is trading at $46. A put option with a strike price of $46 expiring in a month is priced at $1. A trader thinks that MSFT will rise above $46 by expiration, so he sells the MSFT 46 put option expiring in 30 days, and receives a $100 credit ($1 x 100 shares). If he’s right, and MSFT stays above $46 by expiration, then he keeps the $100 credit as a profit.

If he’s wrong, and MSFT drops to $40, then the buyer of the option may exercise his right to sell MSFT at the higher price (the strike price of the option), and the difference would be paid by the seller of the option. In this case, the seller would lose:

(Market Price x 100 shares) - (Strike Price x 100 shares)
($40 x 100) - ($46 x 100)
$4,000 - $4,600 = -$600

Since the seller collects $100 when the trade is placed, the net loss is only $500 (-$600 + $100).

Profit and Loss (P&L) at Expiration