Naked put

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Payoffs and profits from writing a short put
Payoffs and profits from writing a short put

A naked put (also called an uncovered put) is a put option where the option writer (i.e., the seller) does not have a short position in the underlying stock or other instrument.

If the market price of the underlying stock falls below the strike price of the option, the holder can exercise the put option and force the writer to buy the underlying at the strike price for cash, profiting from the difference between the market price and the option's strike price. But if the market price remains at or above the strike price for the duration of the option, the option will expire worthless and the writer will profit from the premium charged to the buyer for the privilege of receiving the option.

The potential loss on a naked put is equal to the strike price minus the premium received and the potential upside is only equal to the premium received for the option. If the stock price stays above the strike price then the put option seller keeps the premium and the option expires worthless. However, if the stock moves down, then the option premium can increase, and it becomes more costly to close the put position. If the stock price completely collapses before the the put position is closed, then the put writer can face potentially catastrophic losses.

[edit] References

  • Investopedia Staff, "Introduction to Naked Puts." "Investopedia" (March 1, 2002)

[edit] External links

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