Covered Put Writing for Equity Options

Now that you understand covered calls, the covered put is its mirror image, applied to a short stock position instead of a long one. The construction and premium logic are the same; only the direction of risk flips.

How Is a Covered Put Constructed?

• A covered put consists of being short 100 shares of the underlying stock and selling (writing) one put option against that short position
• The position is "covered" because the writer is already short the stock and can accept delivery (buy shares) if the put is exercised, closing the short position
• The writer collects a premium, providing income and a limited upside cushion on the short stock position

Think of it this way: A covered call writer owns stock and sells someone the right to buy it. A covered put writer is the mirror image; they have borrowed and sold stock (short), and they sell someone the right to sell it back to them.

What Are the Covered Put's Profit, Loss, and Break-Even Formulas?

• Maximum gain is capped: if the stock falls below the strike, the put is exercised and the writer must buy shares at the strike, closing the short position
• Maximum loss is theoretically unlimited because the stock can rise without limit; the premium only provides a small cushion
• The covered put writer's break-even is higher than the short sale price by the amount of premium received

Example: Short stock at $60, sell a 55 put for $2

Exam Tip: Gotchas

• The break-even for a covered put moves UP from the short sale price (opposite direction from covered calls, where break-even moves down from the purchase price)
• Short stock + sell put → collect premium → premium raises break-even → downside gain is capped at strike → unlimited upside risk remains

When Should You Use a Covered Put?

• Income generation: Earn premium income on a short stock position in flat or slightly bearish markets
• Partial hedge: The premium provides a small buffer against an adverse stock price increase
• The writer must be willing to cover the short position (buy back shares) at the strike price if assigned

How Do Covered Calls and Covered Puts Compare?

Exam Tip: Gotchas

• A covered put writer has UNLIMITED maximum loss (stock can rise without limit). A covered call writer has large but limited loss (stock can only fall to zero). This asymmetry is a key distinction.
• Both covered calls and covered puts provide only partial hedging; the premium received acts as a small cushion, not full protection.

What Should You Check on Exam Day?

• Can you compute max gain, break-even, and confirm max loss is unlimited for a covered put from a word problem?
• Do you remember that the break-even for a covered put moves UP from the short sale price, the opposite direction from a covered call's break-even?
• Can you explain why a covered put's maximum loss is unlimited while a covered call's maximum loss is large but finite (stock can only fall to zero)?
• Would you correctly classify both covered calls and covered puts as partial hedges, not full hedges?