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.
Strategy Construction
- 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.
Profit, Loss, and Break-Even
| Metric | Formula |
|---|---|
| Maximum gain | (Short sale price - strike price) + premium received |
| Maximum loss | Unlimited (stock rises with no ceiling); premium only partially offsets |
| Break-even | Short sale price + premium received |
- 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
| Metric | Calculation | Result |
|---|---|---|
| Max gain | ($60 - $55) + $2 | $7 per share |
| Max loss | Unlimited | Unlimited |
| Break-even | $60 + $2 | $62 |
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 to 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
Covered Call vs. Covered Put Comparison
| Feature | Covered Call | Covered Put |
|---|---|---|
| Stock position | Long 100 shares | Short 100 shares |
| Option sold | Short call | Short put |
| Market outlook | Neutral to slightly bullish | Neutral to slightly bearish |
| Maximum gain | Capped | Capped |
| Maximum loss | Large (stock to zero) | Unlimited (stock can rise forever) |
| Break-even direction | Below purchase price | Above short sale price |
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). The exam tests whether you understand this asymmetry.
- Both covered calls and covered puts provide only partial hedging; the premium received acts as a small cushion, not full protection.