Short Put

Underlying Strategy

Bullish or Neutral

When a trader is bullish on the instrument, or is expecting the instrument to have low movement to the downside. 

Methodology

The trader shorts a Put option of a definite  strike price, assuming that the instrument shall expire at or above the strike price at the time of its expiry.

Risk Profile:

This is a highly risky setup as the loss could be unlimited and the profit potential is limited.

However the probability of successful trades is more in selling OTM options.

Margin requirements are high for this strategy.

Calculations:

Max Potential Profit: Net premium received.

When: The stock is above the strike price at the time of expiry..

Max Potential Loss: Unlimited.

When: The stock crosses the strike price to the downside.

Breakeven at expiration: Strike price-Cost of the PE

Impact with passage of time

The PE price reduces with the passage of time, assuming the instrument price remains constant. Hence time decay works in favor of this strategy. 

Illustration 

Suppose the trader has a view that HDFC  would remain neutral or turn bullish in the near future.

To capture the move he may buy a CE or short a put option.

Since the risk appetite of the trader is good and he is neutral to bullish view of the stock, he decides to short a PE of near month expiry.

HDFC is currently trading at 1569. The trader decides to short 1 lot PE of strike price 1500 of near month expiry, receiving a premium of 14.1

Hence the maximum profit of this strategy shall be (14.1*500)=Rs.7050

Hence the breakeven price for this strategy shall be Rs.( 1500-14.1=1485.9).The strategy would run in to a loss if the stock closes below 1485.9 at the time of expiry.

Now let us consider different scenarios at the time of expiry.

Stock closes at Rs.1550.

Profit= (Net premium received)*Lot Size

Value of the PE will be 0

Hence Profit=(14.1)*500

=Rs.7050

Stock Closes at Rs. 1500

Profit=(Net Premium received)*Lot Size

Value of the PE will be 0

Hence Profit=(14.1)*500

Rs.7050

Stock closes at Rs. 1480

Profit/Loss=(Premium received-(Strike Price-Current stock price)

=(14.1-(1500-1480)*500

=-Rs. 2950 Loss

Stock closes at Rs.1420

Profit/Loss=(Premium received-(Strike Price-Current stock price)

=(14.1-(1500-1420)*500

=-Rs.32950 Loss