This strategy has a low-profit potential if the stock remains above Leg 1 (strike price) at expiration. However, unlimited risk if the stock goes down.
Description
If the stock price declines below the strike price before the put option expires, the buyer of the option may exercise their right to sell the stock at the higher strike price.
The maximum profit for a short put strategy is the premium received, while the maximum loss is limited to the difference between the strike price and the stock price, plus the premium received. The value of the put option will also increase as time passes and is sensitive to changes in volatility.
It’s important to note that selling a put option carries significant risk, as the investor is exposed to potential losses if the stock price declines significantly. As such, this strategy is not suitable for all investors and should be carefully considered before being implemented.
The reason some traders run this play is that there is a high probability of success when selling very out-of-the-money puts. Ensure a stop-loss plan is in place if the stock price goes down.
Breakeven:
Leg 1 minus premium received for the put
Sweet Spot:
The stock price is at or above leg 1 (strike price) at the expiration date.
Max Profit:
Profit is limited to the premium received for selling the put
Max Loss:
Risk is a nearly unlimited loss if the stock keeps going below Leg 1/strike price.
