Short Put

I. Strategy Overview

1) Strategy Composition

In this chapter, we will introduce the last of four basic options strategies: the Short Put.

If you believe that the stock will not decline in the near future, you might consider being a seller of put options.

If the stock price is above the strike price at expiration, the premium you received will be securely retained without the obligation to purchase the underlying asset. However, if, within the agreed timeframe, the stock price falls below the strike price, you will be required to purchase the stock as per the prior agreement.

What we are introducing here is simply selling put options, where the investor primarily hopes to receive the premium, typically does not wish for the option to be exercised, and will not have sufficient cash on hand. This operation is also referred to as 'Uncovered Put' or 'Naked Put.' Similar to Short Call, this strategy has a strong speculative nature and carries higher risk.

If the cash you hold can cover the amount corresponding to the execution of the sold put option, and you wish to acquire the stock when it reaches your target price, this strategy is known as Cash Secured Put.

2) Profit and Loss Analysis

3) Characteristics of the Strategy

Limited Profit: If the underlying stock price does not fall below the strike price at expiration, the value of the put option becomes zero, and the option seller retains the entire premium.

Limited Loss: The seller of the put option is obligated to purchase the underlying asset at the strike price. Since the stock price can only go as low as zero, the theoretical maximum loss from selling a put option is the strike price minus the option premium.

Seller Strategy: This strategy falls under the seller's strategy, receiving the option premium upon opening the position.

II. Case Study

Assuming TUTU is a publicly listed company with a current stock price of $50. You believe that TUTU will not fall below $40 in the near future, so you sell a put option with a strike price of $40 that expires in three months, receiving a premium of $2 per share.

Note: TUTU is not a real stock and is used solely for case demonstration.

Your initial position income:

The income from single stock options is $2, and the total option premium income is $200.

Scenario One: Stock Price < Exercise Price

Assuming that on the expiration date, the stock price of TUTU Company is $30:

You will be obligated to purchase the underlying asset at the exercise price, meaning you will buy 100 shares from the option buyer at a price of $40.

Your loss per share will be: $40 (exercise price) - $30 (current stock price) - $2 (single stock option premium) = $8.

Since each option contract represents 100 shares, your total loss will be 8 * 100 = $800.

If the stock price continues to decline, you may need to buy shares at a higher price than the market price, incurring cash losses. If the losses exceed the option premium received, the strategy will result in an overall loss. In this example, $38 is the breakeven point.

Scenario Two: Stock Price ≥ Exercise Price

Assuming that the stock price of TUTU Company is $55 on the expiration date:

In this case, the option will not be exercisable, and as the seller of the option, you will reap the entire option premium of $200.

3. Operational Guidelines

Step 1: 【Stock Quote Page】 > 【Option Chain】 > 【Single Leg Option】 > Select specific 【Expiration Date】 and 【Strike Price】 > Click 【Trade】

The page defaults to displaying all options for the most recent expiration date; clicking 【Put Options】 will show all put options.

Click on the corresponding option in the option chain and select the direction to sell. A label will appear at the bottom of the page; clicking the upward arrow will display the profit and loss analysis chart. This tool will automatically calculate potential profits based on the underlying stock price, and you can slide left and right on the chart to see how different price points will affect your returns. It also displays information such as profit probabilities and breakeven points.

If you want to learn more about this option, you can also double-click to enter the specific quote page. Assuming you have decided on the put option to sell, you can click 【Trade】 at the bottom left of the page to proceed to the next step.

Step 2: Enter the 【Trading Interface】 > Set 【Trade Direction】, 【Trade Price】, 【Contract Quantity】, and 【Order Type】 > Click 【Sell】

The trading interface for options is similar to that of the underlying stock, with the trade direction confirmed as a sell. It is important to note that there is often a significant price spread in the buying and selling of options; one can choose a mid-range price for placing an order based on trading conditions.

The maximum theoretical loss from selling put options is limited, but significant price fluctuations may expose your account to higher risks. You can utilize the limit order or market order functions on the trading interface to implement stop-loss and take-profit strategies. If the price of the put option reaches your predetermined price level, the system will automatically submit an order to buy back and close the position. However, if the option price changes too rapidly, in some cases the closing operation may not be executed, requiring investors to remain vigilant and, if necessary, opt for a manual closing.

Step 3: Successfully sold option contracts can be found under [Positions] > you can trade or transfer those contracts.

IV. Practical Applications

1) Earning option premiums

When you sell put options, the premium received is akin to an insurance premium, allowing you to earn this income without needing to invest upfront. If the stock price is above the strike price on the expiration date, you can "earn" this additional income effortlessly.

However, if the stock price falls below the strike price, the seller of the put option is obligated to purchase the corresponding number of shares at the strike price. If you do not have sufficient cash on hand, you may need to borrow funds to buy, which could even trigger a forced liquidation.

2) Utilizing volatility premium

Market expectations of future volatility affect option prices, which is referred to as implied volatility. The higher the volatility, the more expensive the option, as the market perceives a greater likelihood of the price fluctuating to the option's strike price.

Market volatility typically increases around events such as company earnings announcements or Federal Reserve meetings. Selling options during these times can yield higher premiums.

If you have sufficient cash and are prepared to purchase the underlying asset after exercising the option (selling cash-secured put options), you can refer to the relevant sections for specific applications.

V. Frequently Asked Questions

A. Which carries a higher risk, Short Call or Short Put? What are the differences?

Selling options without collateral is a high-risk strategy. Comparatively, since stock prices can rise indefinitely, the theoretical loss on a Short Call is unlimited, whereas the risk of a Short Put, although significant, is predictable and limited (maximum loss occurs when the underlying asset price drops to zero). Investors should exercise caution when using these strategies.

B. How can one mitigate risks when employing a selling put option strategy?

You can choose the strike price more cautiously, rather than maximizing based on the premium received. When selecting the strike price, consider a strong support level for the stock price (or lower), which reduces the probability of the option being exercised.

For option sellers, time is your ally. The time value decreases as the expiration date approaches, eventually falling to zero on the expiration date. The process of time decay is nonlinear; the closer it gets to the expiration date, the faster the time value diminishes. Generally, the time value of an option decays most rapidly in the 30 days leading up to expiration.

In practical operations, it is advisable to choose underlying assets with high trading volume and good liquidity for transactions. Low liquidity may result in your inability to close positions at desired prices, and in some cases, you may even be unable to close positions altogether.

C. What should be done if you are exercised after selling a put option, but do not have sufficient cash reserves?

The option seller is the obligated party; if your account does not have enough cash to purchase the corresponding quantity of assets, you can buy them through financing, which will incur additional costs such as interest. If your account's purchasing power is still insufficient, the system will issue a margin call notification. You can choose to deposit sufficient funds to meet the requirements for the underlying asset. If you fail to meet the margin requirement within the stipulated time, the system may force a buyout to close your position. When selling put options, the system will also calculate the maximum number of put options you can sell based on your current account purchasing power.

D. What trading options are available after selling a call option?

Active closing: After selling a put option, if the price of the put option declines as you expected, you may consider buying to close and lock in profits. Conversely, if the market trend diverges from your previous expectations, you should also consider selling to stop losses at an appropriate time. Your profit = (selling price of the option - closing price of the option) * contract multiplier * number of contracts.

Active roll-over: For the same underlying stock, buy back the current put option to close the position and sell a new put option. If you need to adjust the price or time of the option you initially sold, you can use this method for reallocation. However, the roll-over operation also increases transaction costs.

Passive exercise: If an option buyer chooses early exercise, the system will randomly match buyers and sellers, and you may be designated to purchase the stock early; the option seller cannot independently decide when to exercise. However, since early exercise by the buyer equates to voluntarily relinquishing time value, the probability of this situation occurring is relatively low.

Held to expiration: When an option is out of the money, the option will expire automatically, and you will receive the full premium.

When the option is in the money, the option will be automatically exercised, and you will be obligated to purchase the corresponding quantity of the underlying asset at the exercise price.

Automatic exercise conditions:

U.S. stock options: On the expiration date, if the closing price of the underlying stock is $0.01 or more below the exercise price.

Hong Kong stock options: On the expiration date, if the closing price of the underlying stock is 1.5% or more below the exercise price.