Knowledge Base - Short Put

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Short Put

Name: Short Put

Description: The short put obligates you to buy the underlying at the strike price. If the underlying finishes above the strike price your put will expire worthless allowing you to keep the credit. This play carries high risk so caution is advised when putting this play on.

Setup: Sell (short) a put

Bias: Neutral to Bullish

Break-Even: Strike A - Credit received for the sale of the put

Max Profit: Limited: To Credit received

Max Loss: Limited: If the underlying falls below your strike price losses will occur - but are limited due to the fact the underlying cannot fall below $0.00

Margin: Short put requires no cash outlay so margin is used. Margin is calculated by taking the greater of:

25% of the underlying security value minus the out-of-the-money amount plus the premium received or
10% of the underlying security value plus the premium received

Time Decay: As time passes the put will drop in value which is what you want. You want your short put to lose value so it expires worthless or allows you to buy it back (close it) for a lower price.

Implied Volatility: Over the life of the option you want implied volatility to decrease, thus decreasing the price of your option. An increase in implied volatility will increase the price of your option.

Notes: Short puts can profit no matter which direction the underlying moves. Losses will only occur below break-even. Selling deep out-of-the-money puts can return high probability plays. Short puts can also be turned into cash-secured puts. This is setup by holding enough cash to buy the shares if the underlying falls below the strike price. This is a good way to pick up shares at a reduced price. For example if the underlying is currently trading at $65 and you are willing to purchase the stock at $60 then you could sell the put on the 60 strike. If the underlying falls below 60 you will be assigned the shares and now have a long stock position. This is more typical for picking up long-term holdings.

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The exact opposite of “going long”, this is a means by which the investor/trader makes money off of the stock decreasing in value. When executing a short sale, you are selling a stock that you don’t own by borrowing it from your broker and selling it on the open market. Regardless of whether the stock goes up or down in price thereafter, you have to eventually buy back the same amount of shares, of the same stock, on the open market to settle the debt between you and your broker.

A technical pattern used to identify a top in a particular stock. A stock will typically increase in value followed by a mild sell-off, which is the "left shoulder". Then the buyers step in to push the index to new highs, followed by a larger sell-off, that sends prices back to about where the previous low was created. At this point the "head" portion of the pattern has been created. Then finally buyers push the price of the stock back up, but instead of creating a new high, it creates a lower high, which becomes the "right shoulder" of the tecnical patter. Typically these patters take 2 to 3 months to develop or longer. What chart technicians prefer to do is draw a support line underneath the two previous lows, and any break of that support line will be a "sell signal".

The opposite of the upward trendline, it is a line connecting a series of “lower-highs” of price levels of a particular stock. The steeper the trend line the more difficult it is to maintain the trend. A break of the downward trendline or more importantly the creation of a “higher-high” means the trend has been broken and is now either trading “sideways” or has begun a new upward trendline.

A term used for buying stocks in anticipation that the stock will go up in value. This is the most traditional means of investing/trading. Its exact opposite counterpart is “going short”.

A frequent term used by investors and traders that represent the people and funds that are pessimistic on the ability of the market to increase in value. When the market or a particular stock is showing bearish tendencies, that means there is heavy distribution or selling taking place. When the bears lose their sense of pessimism, the markets will then begin to start seeing heavy buying. Remember: when a person says he is “bearish”, understand that he means that he expects the market or a particular stock to decrease in value.

In the absence of an upward or downward trendline, the market is trading sideways. Trading sideways doesn’t necessarily mean it is trading in a narrow range, rather it is trading without either side have a clear advantage. Thus until leadership emerges from the bulls or bears, the market trades sideways.

A line connecting a series of “higher-lows” of price levels of a particular stock. The steeper the trend line the more difficult it is to maintain the trend. A break of the upward trendline or more importantly the creation of a “lower-low” means the trend has been broken and is now either trading “sideways” or has begun a new downward trendline.

The most popular averages used are the 20-day (short-term), 50-day (mid-term), and 200-day (long-term) moving averages. To compute a moving average take the closing price of any stock or index for any particular time period and find the average. For instance, if you wanted the 5-day moving average of a particular stock, and the last 5 trading sessions’ closing prices were 100, 101, 103,101, and 105, you would then add these five numbers together to get 110, then divide by 5, and you have a current 5-day moving average of 102. Each day you add the newest closing price and drop the oldest closing price, and then chart the price movement. Often times these averages represent important areas of support and resistance. For a stock to cross a significant moving average, say the 200-day moving average can cause sentiment of that particular stock to change instantaneously.

Another term for buying which typically takes place at the end of a market sell-off or downward trend, where the selling pressures have evaporated and the buyers have stepped in to start buying stocks in anticipation of a market reversal. This also takes place during a pause on an established upward trend – most notably as price levels show consolidation.

Another term for selling which typically takes place at the end of a market rally or upward trend, where the buying power has evaporated and the sellers have stepped in to start selling their stocks or to begin short sales in anticipation of a market reversal. This also takes place during a pause on an established downward trend, as the bears add more capital to their short positions – most notably as price levels show consolidation.

A term that we often use to describe market conditions that have seen substantial buying for over a period of time, and as a result the bulls may not have enough capital on the sidelines to legitimately keep the rally going. A good indicator for measuring the overbought/oversold conditions of an index, ETF, or stock is by using the Stochastics. A reading over 80 is a signal that the conditions are becoming overbought, while a reading under 20 is a signal that the conditions are becoming oversold.

A price level on the charts where sellers are likely to jump in and attempt to stop a rallying stock, with increased selling power. Often this is an emotional pivot point for sellers in which as much as it is willing to sell at these levels it is also willing to cover their short positions, if there is a break of the resistance level. Resistance is also marked by time in that the more recent the resistance level, the fresher it is in the minds of sellers and the more loyal they are to it. The older the resistance level, the weaker it will tend to be. Identical resistance levels across various points of time often add increased resistance. Stop-losses are often times, placed above a resistance level, which adds to the buying/covering if there is a breach. Also note that once a resistance level is broken, and price moves beyond it, it thereby becomes a level of support for buyers.

This occurs to the downside when after a period of sideways trading or trading within a range, when a stock moves down and outside of that range, it is considered to be breaking down. Often times this marks the beginning of a long-term sell-off that can provide substantial profits for those who spot the breakdown early on.

This occurs to the upside when after a period of sideways trading or trading within a range, when a stock moves up and outside of that range, it is considered to be breaking out. Often times this marks the beginning of a long-term rally that can provide substantial profits for those who spot the breakout early on

A term that we often use to describe market conditions that have seen substantial selling for over a period of time, and as a result the bears may not have enough capital on the sidelines to legitimately sustain the sell-off. A good indicator for measuring the overbought/oversold conditions of an index, ETF, or stock is by using the Stochastics. A reading over 80 is a signal that the conditions are becoming overbought, while a reading under 20 is a signal that the conditions are becoming oversold.

A price level on the charts where buyers are likely to jump in and attempt to stop a declining stock, with increased buying power. Often this is an emotional pivot point for buyers in which as much as it is willing to buy at these levels, it is also willing to sell if there is a break of the support level. Support is also marked by time in that the more recent the support level, the fresher it is in the minds of buyers and the more loyal they are to it. The older the support level, the weaker it will tend to be. Identical support levels across various points of time often add increased support. Stop-losses are often times, placed below a support level, which adds to the selling if there is a breach. Also note that once a support level is broken, and price moves below it, it thereby becomes a level of resistance for sellers.

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