====== Covered Put ======
A Covered Put (also known as a 'short stock, short put' strategy) is an options trading strategy where an investor simultaneously holds a [[short selling|short position]] in a stock and sells a [[put option]] on that same stock. It's a strategy for investors who are bearish, meaning they expect the stock's price to decline. The goal is to generate income from the [[premium]] received for selling the put option, which either enhances the profit from the short stock position or cushions some of the loss if the stock price unexpectedly rises. Unlike its more popular cousin, the [[covered call]], the covered put is a complex strategy with a risk-reward profile that can be tricky for newcomers. While it offers a limited, defined profit, it also carries the potential for theoretically unlimited losses, a characteristic that makes most [[value investing|value investors]] tread very carefully.
===== What Is a Covered Put? =====
Think of a covered put as a two-part bet on a stock's decline.
  * **Part 1: The Short Stock.** You borrow shares of a company you believe is overvalued and immediately sell them on the open market. Your hope is to buy them back later at a lower price, return them to the lender, and pocket the difference. This is a classic bearish move.
  * **Part 2: The Short Put.** You sell (or "write") a put option. By doing this, you collect an upfront cash payment (the premium) and take on the obligation to buy the stock at a specified price (the [[strike price]]) if the option [[option holder|holder]] chooses to exercise it before the [[expiration date]].
By combining these two actions, the short stock position "covers" the obligation you took on by selling the put. If the stock price plummets and you are forced to buy the shares at the strike price, you can simply use those shares to close out your short position. The strategy essentially puts a cap on your potential profit in exchange for the upfront premium income.
===== How Does a Covered Put Work? =====
Let's walk through an example to see the mechanics in action. Imagine you're bearish on "GadgetCorp" (GC), which is currently trading at $50 per share. You decide to implement a covered put strategy.
==== The Setup ====
  1. **Short the Stock:** You short 100 shares of GC at $50, receiving $5,000 in your account (minus any borrowing fees).
  2. **Sell the Put:** You sell one GC put option contract (which represents 100 shares) with a strike price of $45 that expires in one month. For selling this put, you receive a premium of $2 per share, totaling $200.
Your total initial cash inflow is $200. Your goal is for GC's stock price to fall, ideally to just above or at the $45 strike price by expiration.
==== The Payoff Scenarios ====
=== Scenario 1: The Stock Price Plummets (e.g., to $40) ===
This is your best-case scenario. The put option you sold is now [[in-the-money]], and the buyer will exercise it. You are obligated to buy 100 shares of GC at the $45 strike price, costing you $4,500. You then use these shares to close your short position.
  * **Profit Calculation:** (Price you shorted at - Price you bought back at) x 100 shares + Premium received
  * **Your Profit:** ($50 - $45) x 100 + $200 = $500 + $200 = **$700**
This is your //maximum possible profit//, locked in no matter how much further the stock falls.
=== Scenario 2: The Stock Price Rises (e.g., to $55) ===
This is the risky scenario. The put option you sold is [[out-of-the-money]] and will expire worthless. You get to keep the $200 premium, which is good. However, your short stock position is now losing money. To close your position, you must buy back 100 shares at the market price of $55, costing you $5,500.
  * **Loss Calculation:** (Price you shorted at - Price you bought back at) x 100 shares + Premium received
  * **Your Loss:** ($50 - $55) x 100 + $200 = -$500 + $200 = **-$300**
Because a stock's price can theoretically rise indefinitely, your potential loss on the short position is **unlimited**. The $200 premium you collected only slightly offsets this massive risk.
=== Scenario 3: The Stock Price Stays a Little Below (e.g., to $48) ===
The put option expires worthless, and you keep the $200 premium. Your short position has made a small profit. You buy back 100 shares at $48 to close the position.
  * **Profit/Loss:** ($50 - $48) x 100 + $200 = $200 + $200 = **$400**
===== A Value Investor's Perspective =====
For followers of value investing, the covered put is often viewed with skepticism. The philosophy of value investing is built on buying wonderful companies at fair prices and holding for the long term, not on short-term bets on price declines.
==== The Good: A Tool for Specific Situations ====
While not a core strategy, a sophisticated investor might use a covered put to express a strong, well-researched bearish conviction on a demonstrably overvalued company. It can be seen as a way to generate income while waiting for the market to correct what you perceive as an irrational price. It's a far more active and speculative approach than, say, simply avoiding the stock or selling a [[cash-secured put]] on a company you'd love to own at a lower price.
==== The Bad: Unlimited Risk and Market Timing ====
The primary red flag for a value investor is the unlimited loss potential. This directly contradicts the core principle of "Margin of Safety," which is about protecting your downside. Shorting a stock, which is a required component of the covered put, can be ruinous. A stock you think is overvalued can always become //more// overvalued due to market mania, short squeezes, or unexpected good news. The strategy's success also relies heavily on timing the market, which is a notoriously difficult, if not impossible, game to win consistently.
===== Covered Put vs. Naked Put =====
It's crucial not to confuse a covered put with a [[naked put]].
  * **Covered Put:** You are short the stock. The short stock position "covers" the risk of the stock price //falling//. Your major risk is the stock price //rising//.
  * **Naked Put:** You have no position in the stock. You are simply selling the put, hoping the price stays above the strike. Your major risk is the stock price //falling//, potentially all the way to zero.
The term "covered" here can be misleading. It does not mean the position is safe; it simply means that one risk (a falling stock price) has been hedged, but it has been replaced by another, arguably bigger risk (a rising stock price). This usually requires a [[margin account]] and a high-risk tolerance.
===== Key Takeaways =====
  * A covered put is an advanced, bearish options strategy that combines shorting a stock with selling a put option on it.
  * The maximum profit is limited and is achieved if the stock price falls to or below the strike price.
  * The maximum loss is theoretically unlimited due to the risk from the short stock position if the price rallies.
  * It is generally not considered a suitable strategy for conservative, long-term value investors due to its speculative nature and unfavorable risk-reward profile.
  * It is the inverse of the more common covered call strategy and should not be confused with a cash-secured put, which is a bullish strategy.