Short Selling Vs. Put Options: How Payoffs Differ

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There are two types of options - calls and puts. Also, for constructing these payoff diagrams I have ignored option premiums so we can focus on the payout. Option premiums can be considered constants that move the entire graph up or down, without changing its shape which is what we are interested in. The payoff for a stock position is linear. The payoff increases or decreases linearly with price, depending upon whether it is a long or a short position.

A long position in a call option has a zero pay off till the exercise price, after which its payoff is identical to that of the stock. Here is a simple trick that some may find useful to remember what option payoff diagrams look like.

The one pay-off diagram you will need to remember is the long call. Recall that this looks as follows:. To get the short call pay-off diagram, assume there is an imaginary mirror placed on the x-axis. This applies to every option position, or complex set of positions. To get the long put position from short position put option graph long call, imagine there is a mirror along the y-axis this short position put option graph. You get the pay-off from a long put position.

Given this, you can visualize the payoff from a short put position too. Complex options positions can be understood by combining payoff diagrams. Next, we will combine payoff diagrams to understand the put-call parity. Imagine an options portfolio with a long call and a short put position, short position put option graph with the same exercise price.

This will have the following payoff:. Compare the resulting payoff — the diagram on the right hand side. This looks just like the payoff for the stock, except that the line is a bit lower. And it is lower by exactly the amount of the exercise price, present valued to today. By combining a long call short position put option graph a short put, we end up with a linear payoff, just like for the stock. This linear payoff, combined with a bank deposit, has a payoff identical to a stock:.

This is the put-call parity. Notice the right hand side of this equation. The exercise price is a constant, and so is the spot price. So at any point in time, RHS is fixed. Therefore if call prices rise, put prices would rise need to rise too in order to maintain the parity. The minus sign indicates a short position. Payoff for a stock position The payoff for a stock position is linear.

The payoff from a short stock position is just the opposite: The payoffs for a short call, a long put and a short put short position put option graph given below: How to remember what different payoff diagrams look like: Recall that this looks as follows: Combining payoffs Complex options positions can be understood by combining payoff diagrams. Understanding put-call parity Imagine an options portfolio with a long call and a short put position, both with the same exercise price.

This will have the following payoff: This linear payoff, combined with a bank deposit, has a payoff identical to a stock: Combining the two, we get: This can also be written as: So we can write the put call parity as: Introduction to vanilla options.

Payoff diagrams There are two types of options - calls and puts.

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This page explains short put option payoff. You can find similar pages for the other basic option positions here: A short put option position is a bullish strategy with limited upside and limited but usually very high risk. The position is initiated by selling a put option with the intention to buy it back later at a lower price or waiting until expiration and hoping it will expire out of the money. See the payoff chart below:. The payoff is inverse of long put position , which is the other side of your trade.

Below the strike price your profit declines in proportion with the underlying price. In this example we have sold one contract of a 45 strike put option for the price of 2. The maximum you can gain from a short put trade is the amount you receive at the beginning when selling the put. If the option expires worthless, there is no more cash flow from the trade and you keep all the initial cash, which is also your total profit.

The worst case scenario is when the underlying price drops to zero. Because the underlying is now worthless, you lose the amount equal to the strike price per share. Total loss from the trade is therefore equal to the strike price less the initial amount you have received when selling the put.

The risk-reward ratio is usually quite unfavourable with a short put position, as the maximum possible loss is usually much higher than potential profit of the trade. If you have seen the explanation of long put option payoff formulas , you will find the short put payoff formulas are exactly the same, only with opposite signs , as you are now taking the other side of the trade.

The break-even point of a short put position is exactly the same as long put break-even. This particular short put trade is profitable if the underlying ends up above If you don't agree with any part of this Agreement, please leave the website now. All information is for educational purposes only and may be inaccurate, incomplete, outdated or plain wrong.

Macroption is not liable for any damages resulting from using the content. No financial, investment or trading advice is given at any time. Home Calculators Tutorials About Contact. Tutorial 1 Tutorial 2 Tutorial 3 Tutorial 4. Short Put Payoff Diagram and Formula.

Short Put Payoff Diagram A short put option position is a bullish strategy with limited upside and limited but usually very high risk. See the payoff chart below: Short Put Maximum Profit The maximum you can gain from a short put trade is the amount you receive at the beginning when selling the put. Short Put Maximum Loss The worst case scenario is when the underlying price drops to zero. Short Put Risk-Reward Ratio The risk-reward ratio is usually quite unfavourable with a short put position, as the maximum possible loss is usually much higher than potential profit of the trade.

Short Put Payoff Formulas If you have seen the explanation of long put option payoff formulas , you will find the short put payoff formulas are exactly the same, only with opposite signs , as you are now taking the other side of the trade. There are again two components of the total profit or loss: Short Put Payoff Summary Short put strategy is directional and bullish. It is also a short volatility strategy, as the value of a put option declines when volatility decreases, which means your short put position becomes more profitable.

You want the underlying price to end up above the strike price, so the put option expires worthless and you keep the entire premium. Short put strategy has limited upside, equal to the cash you get when selling the put option in the beginning. This is the maximum you can gain from the trade. It has limited risk unlike a short call trade whose risk is unlimited , equal to the strike price less the initial option price. However, in most cases the option price is much lower than the strike price, which means the maximum possible loss is typically much higher than the potential profit.