A cash-secured put is an income options strategy in which an investor sells a put option on a stock while setting aside the cash to buy that stock, in case the stock price drops below the strike price of the put option and is assigned to the investor.
This strategy is useful for investors who believe a stock may drop in price over the short term and then increase long term. It allows the investor to generate income on the sale of the put, set the price (strike price) at which they will buy the stock if assigned, and enter a stock position at a lower price than when the trade is initiated.
The Details of Selling a Cash-Secured Put
Put options and call options are a type of derivative that may allow investors to gain — not by owning the underlying asset and waiting for it to go up, but by strategically using options contracts to profit from the asset’s price movements.
Similar to the strategy of shorting stocks, the way investors use options reflects their view on whether the price is likely to go up or down.
Selling cash-secured puts is a bullish options trading strategy that involves selling a put option with the hope that it either expires, or the underlying security temporarily drops in price and lets the investor purchase the security at the lower price.
Selling a put obliges an investor to purchase a certain number of stock or ETF shares at a specific price (the strike price) by a specific future date (the expiration date). Investors will choose a put that is out-of-the-money, i.e., with a lower strike price than the current stock price.
What to Consider With Cash-Secured Puts
Investors earn a premium immediately when they sell the cash-secured put. This is a strategy where investors generally sell cash-secured puts associated with securities they don’t own, that they expect to decrease in value in the near future but increase over the long term.
The contract may also require the investor to purchase the security prior to the exercise date if the price of the security drops to lower than the strike price. If the market price of the security is lower than the strike price at the exercise date, the investor still has to purchase the security at the strike price.
If the market price of the security is higher than the strike price at the exercise date, the investor is not obligated to purchase the security and the put expires. In this case, the investor has earned the premium amount and profited from the trade, as they say in options terminology.
Investors are required to have enough cash in their trading account to cover the full purchase amount. The investor must maintain that cash amount in their brokerage account for the duration of time they hold the put, which is why it’s called a cash-secured put.
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Some investors in puts don’t ever plan to purchase the underlying security, they simply want to profit off of the options premium. In that case they would generally write a naked put, which doesn’t require them to hold the cash to purchase the security.
The investor would hope that the put expires without obligating them to buy, and they could pocket the premium amount. Cash-secured puts are geared towards investors who actually want to purchase the underlying security on or before the exercise date at a price of their choosing.
There are some benefits to selling cash-secured puts, and they can be profitable, but investors should understand the risks before trying this investment strategy.
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Pros & Cons of Cash-Secured Puts
Options strategies require the investor to be aware of multiple issues and cash-secured puts are no different.
What Are the Pros of Cash-Secured Puts?
• The investor earns the premium amount regardless of whether they end up purchasing the security.
• If the stock price decreases below the strike price, the investor can purchase the security at the strike price of the put which will be lower than the stock price when the trade was initiated.
Note that if the stock price drops below the strike price and the shares are assigned, the investor will still pay the strike price for the shares. Be sure to think about what determines the stock price of the underlying.
• If the price ends up increasing instead of decreasing, the put will expire worthless and the investor keeps the premium and the cash set aside for the stock purchase.
• If an investor thinks a security is going to decrease in value in the short term but increase over the long term, cash-secured puts are a way they can purchase the security at a price less than the current market value.
• Maximum gains from the put option have a limit, but potential long-term gains after the put option is exercised are unlimited.
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What Are the Cons of Cash-Secured Puts?
• The security might drop below the strike price, it could even fall to $0. It might seem unlikely that a large corporation would go bankrupt, but it has happened before and can happen again.
In this case the investor would still be obligated to purchase the security at the higher strike price, and would then hold a worthless security. However, even if the security plummets, the investor would still earn the premium amount, and their losses would be less than if they’d simply purchased the security instead of selling the put option.
• When entering the trade the investor must be prepared to accept the strike price no matter what happens in the market before the exercise date.
◦ Maximum loss = strike price x 100, minus the premium amount
◦ Maximum gain = premium amount
• A cash-secured put allows the investor to wait for a dip in the security’s price. If the security ends up increasing in value without a short-term dip, the investor has missed out on the opportunity to purchase the security. The put will expire worthless and they will need to make a decision whether to buy at the new, higher price or enter a different trade.
If an investor knows they want to purchase the security they may want to consider other investing strategies or simply purchase the security at the current market price instead of using the cash-secured put strategy.
• The investor must hold enough cash to cover the cost of the security for the duration of the trade. This means they can’t invest that cash into other trades.
• From a short-term perspective, the potential losses from a cash-secured put option trade are high and the potential gains from the put option itself are low.
Tips for Employing a Cash-Secured Put Strategy
• If an investor is bullish on a security, they should choose an out-of-the-money put option with a strike price below the current market price of the stock.
• When an investor sets a strike price that is far out-of-the-money, they receive a lower premium and the option is less likely to be exercised.
• Investors who are very bullish on a security in the short term should choose other investing strategies. Cash secured-put options are best if the investor has a neutral to slightly bullish view of the security.
• It’s best to sell cash-secured put options when implied volatility of a security is high, because this results in higher option premiums. One way to find securities with high implied volatility is to look for high-quality stocks that have recently declined. The decline is likely to be somewhat temporary but the investor can get in at a lower market price with a higher premium. However, just because a company is large doesn’t mean its stock can’t continue to drop, so it’s important to do a detailed analysis before choosing any securities.
• Due to the risk of a security’s price dropping more than the investor expects in the short term, it’s best to only sell put options for companies that the investor has researched.
• Investors generally sell puts with 30-90 day time frames, but some investors choose to sell weekly put options.
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Cash-secured puts are one possible way to generate income while an investor waits for a stock to drop to their desired entry price. Selling cash-secured puts is a bullish options trading strategy that involves selling a put option with the hope that it either expires, or the underlying security temporarily drops in price and lets the investor purchase the security at the lower price.
And while this strategy is not without risk, it can allow the investor to generate short-term income on the sale of the put, set the price (strike price) at which they will buy the stock if assigned, and enter a stock position at a lower price than when the trade is initiated.
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