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Option Strategies

Covered Put

Introduction

A Covered Put consists of a short position in a stock and a short position in put Options for the same amount of stock. Covered puts aim to profit from the Option premium by selling puts written on the stock you already shorted. At any time for American Options or at expiration for European Options, if the stock moves below the strike price, you keep the premium and still maintain the underlying Equity position. If the underlying price moves above the strike, the Option buyer can exercise the Options contract, which mean you buy the stock at the strike price but you will still keep the premium. Another risk of a covered put comes from the short stock position, which can drop in value.

Implementation

Follow these steps to implement the covered put strategy:

  1. In the Initializeinitialize method, set the start date, end date, starting cash, and Options universe.
    2. private Symbol _symbol;

public override void Initialize()
{
    SetStartDate(2014, 1, 1);
    SetEndDate(2014, 3, 1);
    SetCash(100000);

    UniverseSettings.Asynchronous = true;
    var option = AddOption("IBM");
    _symbol = option.Symbol;
    option.SetFilter(universe => universe.IncludeWeeklys().NakedPut(30, 0));
}
    def initialize(self) -> None:
    self.set_start_date(2014, 1, 1)
    self.set_end_date(2014, 3, 1)
    self.set_cash(100000)

    self.universe_settings.asynchronous = True
    option = self.add_option("IBM")
    self._symbol = option.symbol
    option.set_filter(lambda universe: universe.include_weeklys().naked_put(30, 0))

    The NakedPutnaked_put filter narrows the universe down to just the one contract you need to form a covered put.

  2. In the OnDataon_data method, select the Option contract.
    3. public override void OnData(Slice slice)
{
    if (Portfolio.Invested ||
        !slice.OptionChains.TryGetValue(_symbol, out var chain))
    {
        return;
    }

    // Find ATM put with the farthest expiry
    var expiry = chain.Max(x => x.Expiry);
    var atmput = chain
        .Where(x => x.Right == OptionRight.Put && x.Expiry == expiry)
        .OrderBy(x => Math.Abs(x.Strike - chain.Underlying.Price))
        .FirstOrDefault();
    def on_data(self, slice: Slice) -> None:
    if self.portfolio.invested:
        return

    chain = slice.option_chains.get(self._symbol)
    if not chain:
        return

    # Find ATM put with the farthest expiry
    expiry = max([x.expiry for x in chain])
    put_contracts = sorted([x for x in chain
        if x.right == OptionRight.PUT and x.expiry == expiry],
        key=lambda x: abs(chain.underlying.price - x.strike))

    if not put_contracts:
        return

    atm_put = put_contracts[0]
  3. In the OnDataon_data method, place the orders.

    4. Approach A: Call the OptionStrategies.CoveredPutOptionStrategies.covered_put method with the details of each leg and then pass the result to the Buybuy method.

    var coveredPut = OptionStrategies.CoveredPut(_symbol, atmput.Strike, expiry);
Buy(coveredPut, 1);
    covered_put = OptionStrategies.covered_put(self._symbol, atm_put.strike, expiry)
self.buy(covered_put, 1)

    Approach B: Create a list of Leg objects and then call the Combo Market Ordercombo_market_order, Combo Limit Ordercombo_limit_order, or Combo Leg Limit Ordercombo_leg_limit_order method.

    var legs = new List<Leg>()
    {
        Leg.Create(atmPut.Symbol, -1),
        Leg.Create(chain.Underlying.Symbol, -chain.Underlying.SymbolProperties.ContractMultiplier)
    };
ComboMarketOrder(legs, 1);
    legs = [
    Leg.create(atm_put.symbol, -1),
    Leg.create(chain.underlying.symbol, -chain.underlying.symbol_properties.contract_multiplier)
]
self.combo_market_order(legs, 1)

Strategy Payoff

The payoff of the strategy is

$$ \begin{array}{rcll} P^{K}_T & = & (K - S_T)^{+}\\ P_T & = & (S_0 - S_T + P^{K}_0 - P^{K}_T)\times m - fee \end{array} $$ $$ \begin{array}{rcll} \textrm{where} & P^{K}_T & = & \textrm{Put value at time T}\\ & S_T & = & \textrm{Underlying asset price at time T}\\ & K & = & \textrm{Put strike price}\\ & P_T & = & \textrm{Payout total at time T}\\ & S_0 & = & \textrm{Underlying asset price when the trade opened}\\ & P^{K}_0 & = & \textrm{Put price when the trade opened (credit received)}\\ & m & = & \textrm{Contract multiplier}\\ & T & = & \textrm{Time of expiration} \end{array} $$

The following chart shows the payoff at expiration:

Strategy payoff decomposition and analysis of covered put

The maximum profit is $S_T - K + P^{K}_0$. It occurs when the underlying price is at or below the strike price of the put at expiration.

If the underlying price increase, the maximum loss is unlimited.

If the Option is American Option, there is a risk of early assignment on the contract you sell.

Example

The following table shows the price details of the assets in the algorithm:

AssetPrice ($)Strike ($)
Put1.37185.00
Underlying Equity at start of the trade186.94-
Underlying Equity at expiration190.01-

Therefore, the payoff is

$$ \begin{array}{rcll} P^{K}_T & = & (K - S_T)^{+}\\ & = & (185 - 190.01)^{+}\\ & = & 0\\ P_T & = & (S_0 - S_T + P^{K}_0 - P^{K}_T)\times m - fee\\ & = & (186.94 - 190.01 + 1.37 - 0)\times m - fee\\ & = & -1.70 \times 100 - 2\\ & = & -172 \end{array} $$

So, the strategy loses $172.

The following algorithm implements a covered put strategy:

public class CoveredPutAlgorithm : QCAlgorithm
{
    private Symbol _put, _symbol;
    
    public override void Initialize()
    {
        SetStartDate(2014, 1, 1);
        SetEndDate(2014, 3, 1);
        SetCash(100000);

        var option = AddOption("IBM");
        _symbol = option.Symbol;
        option.SetFilter(universe => universe.IncludeWeeklys().NakedPut(30, 0));

        // use the underlying equity as the benchmark
        SetBenchmark(_symbol.Underlying);
    }

    public override void OnData(Slice slice)
    {
        if (_put != null && Portfolio[_put].Invested) return;

        if (!slice.OptionChains.TryGetValue(_symbol, out var chain)) return;

        // Find ATM put with the farthest expiry
        var expiry = chain.Max(x => x.Expiry);
        var atmPut = chain
            .Where(x=> x.Right == OptionRight.Put && x.Expiry == expiry)
            .OrderBy(x => Math.Abs(x.Strike - chain.Underlying.Price))
            .FirstOrDefault();

        if (atmPut == null) return;

        var coveredPut = OptionStrategies.CoveredPut(_symbol, atmPut.Strike, expiry);
        Buy(coveredPut, 1);

        _put = atmPut.Symbol;
    }
}
class CoveredputAlgorithm(QCAlgorithm):
    def initialize(self) -> None:
        self.set_start_date(2014, 1, 1)
        self.set_end_date(2014, 3, 1)
        self.set_cash(100000)

        option = self.add_option("IBM")
        self.symbol = option.symbol
        option.set_filter(lambda universe: universe.include_weeklys().naked_put(30, 0))

        self.put = None

        # use the underlying equity as the benchmark
        self.set_benchmark(self.symbol.underlying)

    def on_data(self, slice: Slice) -> None:
        if self.put and self.portfolio[self.put].invested:
            return

        chain = slice.option_chains.get(self.symbol)
        if not chain:
            return

        # Find ATM put with the farthest expiry
        expiry = max([x.expiry for x in chain])
        put_contracts = sorted([x for x in chain
            if x.right == OptionRight.PUT and x.expiry == expiry],
            key=lambda x: abs(chain.underlying.price - x.strike))

        if not put_contracts:
            return

        atm_put = put_contracts[0]

        covered_put = OptionStrategies.covered_put(self.symbol, atm_put.strike, expiry)
        self.buy(covered_put, 1)

        self.put = atm_put.symbol

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