A Covered Put is a strategy where you short the underlying (e.g., BANKNIFTY Futures) and sell a put option at a lower strike price to earn premium income. It works best when the underlying price is expected to fall slightly but stay above the strike price.
- Ideal for moderately bearish conditions, where a modest price decrease is expected.
- Selling a put 1-2% OTM from the current price provides premium income with a lower risk of being exercised.
- Generates additional income from the premium, with limited upside protection if the price rises.
- Maximum profit occurs if the underlying closes at or above the strike price, with profit being the premium collected.
- Risk arises if the price rises significantly, as gains on the futures are capped.
Example:
- BANKNIFTY trading at 42,000.
- You short 1 lot of BANKNIFTY Futures (lot size = 25) at 42,000.
- Sell 41,700 Put (OTM) at ₹120 with a near-month expiry.
- Outcome:
- If BANKNIFTY stays above 41,700 at expiry:
- The put option expires worthless.
- You retain the ₹3,000 premium (₹120 × 25).
- If BANKNIFTY falls to 41,600 at expiry:
- Loss on futures = ₹10,000.
- Net loss = ₹10,000 − ₹3,000 = ₹7,000.
- If BANKNIFTY rises to 42,300 at expiry:
- Profit on futures = ₹7,500.
- Effective profit = ₹7,500 + ₹3,000 = ₹10,500.
- If BANKNIFTY stays above 41,700 at expiry: