Definition of ‘Short Put’
A type of strategy regarding the selling of a put option. The option itself is a security in its own right, as it can be purchased and sold. Should the holder of the option believe that the price of the underlying security will increase before the contract’s expiry date, he may buy the underlying stock. Or he may sell the put option (hence “short put”), which requires him to buy the stock, should the put buyer demand he do so.
Investopedia explains ‘Short Put’
A short put position is effectively a form of insurance, guarding the investor against losses beyond a certain point. When the investor enters a short put position, the security’s price must rise in order for the strategy to turn a profit. Furthermore, the price must rise by at least the price of the put option (the “premium”). The higher the price rises, the more money the investor makes. Conversely, should the investor have initially erred and the security’s price then fall, the strategy would lose money. The upper bound on the losses is the value of the stock.
When an investor enters into a short put strategy, he or she is locking the price of an underlying security at the strike price and keeping the premium for writing the put option. Entering into a short put position is considered a risky strategy because an investor is bound by a profit limited to the premium received for selling the put option, but exposed to a higher potential loss only bounded by the underlying security going to zero minus the premium received.
To understand the basics of selling put options, see “Introduction To Put Writing.“