Deep In-the-Money Put is a very bullish option strategy that has a credit
option-info and options-graphs sites:
Strategy: Deep In-the-Money Short Put
Sell a deep In-the-Money Put with a couple months or more to expiration.
when: Stock rises.
Gain: Limited by strike price sold.
when: Stock falls.
Loss : Limited only by stock falling to zero.
Calculation: Strike price sold x number of shares represented - initial
compared to stock: Tremendously increased leverage, credit entry.
compared to stock: Tremendously increased leverage works to the downside
as well, no dividends, limited life.
after entry, an increase in implied volatility is negative.
after entry, the passage of time is positive if the stock rises.
Requirement : If you maintain enough cash to buy the stock at the
strike price of the short put, your broker will consider the short put
to be a CSEP (cash secured equity put), with no further margin requirement.
If the short put is considered "naked", then the minimum margin
would be 10% of the strike price of the short put times the number of
shares represented, but probably more.
Equivalent: Long Stock and Short Call at deep OTM strike price. (Covered
- This "stock
substitute" strategy takes advantage of the fact that Deep ITM
Puts have a very high Delta. This
means the Short Put will lose value almost as fast as the long stock
would gain value on a rise in stock price. And since you are short the
Put, you want it to lose value.
since you are selling a Put, the strategy is entered for a credit, instead
of the debit that actual stock purchase would require.
- This strategy
should only be used if you are very bullish on a stock. If the stock
drops, your dollar losses will be just as large as if you owned stock.
- You normally
would want to sell a put with enough time to expiration for the stock
to make the move you expect. In the example, if you estimate that a
move from 50 to 60 might take four months, you would use the 60 strike
put expiring in four months.
- The short
strike will limit your gains to that strike price. So if you thought
the example stock might make it to 75, then you should sell the 75 strike
- One possible
use for this strategy is "bottom fishing" without using any
cash. If you feel a drop in a stock or index has been overdone, and
especially if the implied volatility has risen because of the drop,
then you may make good gains with no cash outlay. The higher IV means
you will get more for selling the put, which provides a little bit more
"downside protection". Always use a stop loss in case your
timing is not correct.
- This strategy
can also give very good reward to risk ratios on low priced, beaten
down stocks. For instance, you find a company trading at a share price
of $1, but you feel this is just a temporary setback and a year from
now the company and stock price will recover to at least $10. The low
stock price puts a floor under the stock - it can only go down another
$1, like a built-in $1 per share stop loss. You sell a 10 strike LEAP
put for $8.80. The best you can do is keep the $880 if the stock is
over 10 at expiration. The worst you can do is be put to at $10 with
the stock at 0, for a $120 loss. Your reward to risk is 7.3 to 1.
- This strategy
can have dollar losses as large as if you actually owned the stock.
For this reason, you should always have a stop loss, just as you would
if you owned stock.
you are short a put, you can have stock put to you at any time, especially
if the time value of the short put drops to .05 or .10. This doesn't
really cause a problem, since you can then just sell the stock to lock
in a gain, and then sell another put if you are still bullish on the
- For instance,
you enter the example trade for a credit of $1063. The stock rises to
58 near expiration, but the time value of the put goes to .05 and someone
puts the stock to you at $60, a $6000 debit. You immediately sell the
stock for $58, a $5800 credit. You lock in $1063 - $6000 + $5800, or
a gain of $863. If you had owned 100 shares of the stock and it went
to $58, you would have made only $800.
- As you
can see, the effect of being put to and immediately selling the stock
is that you capture the time value you sold, in addition to any gain
in the stock price. The $1063 you received for selling the example put
included $10 of intrinsic value, and .63 of time value.