The cash-secured put payoff, and where it breaks even

A short put payoff chart is flat above the strike and turns down at the strike, falling one for one with the stock from there. Your break-even is the strike minus the premium received. Maximum profit is the premium. Maximum loss is the break-even times 100, which happens if the stock goes to zero.

The chart has one bend in it. Everything worth knowing about this trade is on one side of that bend or the other.

Above the strike: the flat part

Stay with the PFE trade: stock at $26.40, $25 put sold for $0.55, 49 days out. At $26 on expiry you make $55. At $30 you make $55. At $58 you make $55. The line does not rise, ever.

That flatness is the price of admission. If PFE runs 40 percent on takeover chatter you collect fifty-five dollars and watch. People who sell puts on stocks they are bullish on discover this and hate it, and they are right to, because the honest comparison against just buying the shares has a crossover price and it is not far away.

The bend, at $25.00

At exactly the strike the put is worth zero and you still keep the whole premium. One cent below and exercise by exception puts the shares in your account. There is no gentle transition here. It is a step.

Break-even, at $24.45

Strike minus premium. $25.00 minus $0.55. Below $24.45 you are losing real money on this position, and above it you are not, and that single number is more useful than the strike itself when you are deciding whether the trade is worth doing.

Notice what break-even is not. It is not a floor, a stop, or a level where anything happens. Nothing on the exchange knows about $24.45. It is arithmetic, and its only job is to tell you how much room you bought.

Here that room is 7.4 percent below where PFE actually trades. $26.40 down to $24.45. Whether 7.4 percent of cushion over 49 days is enough is a question about PFE, not about options.

Below break-even: the diagonal

From $24.45 the line falls at 45 degrees and does not stop. At $20 you are down $445. At $15 you are down $945. At zero you are down $2,445, which is the maximum loss, and it is worth writing out in full at least once: two thousand four hundred and forty-five dollars, to collect fifty-five.

That ratio is the honest shape of premium selling. You are taking a small, likely gain against a large, unlikely one. Anyone describing this as conservative without saying that number out loud is selling you something.

The thing nobody mentions: this is a covered call

Draw a covered call on PFE at the $25 strike. Long 100 shares, short the $25 call. Now draw this short put. Same shape. Flat on the upside, falling one for one on the downside, bend in the same place.

That is not a coincidence or an analogy. Put-call parity makes a cash-secured put and a covered call at the same strike and expiry the same position, economically, differing by the cost of carry and the dividend. Which means the argument people have about whether puts or covered calls are safer is mostly not an argument about risk. It is an argument about whether you would rather hold the shares while you wait, and collect the dividend, or hold the cash.

The real differences are small and they are all administrative: dividends, the tax year the premium lands in, and how many shares you have to own to start. Not the payoff. The payoff is the same.

Drawing your own

Three inputs and you have the whole picture: strike, premium, and the price the stock is at now. The payoff diagram builder will draw it, and switching the leg from a short put to a covered call at the same strike is the fastest way to convince yourself of the paragraph above.

Questions people actually ask

Keep reading

• The trade end to end, with real numbers
• Against just buying the shares
• Turning the premium into a yearly rate

Do the math on your own trade

• Payoff diagram builder draw the position and see where the line goes flat.
• Break-even calculator the price where the trade stops making money.
• Cash-secured put calculator credit, break-even, return on secured capital, annualized.

Every price in this article is an illustrative worked example, not a quote. Read Cash-secured puts for the rest of the series, and the disclaimer before you act on any of it. Selling options carries real risk of loss, and the loss can be far larger than the premium you collected.