?> What Is a Cash-Secured Put? Get Income or Cheap Stock - projectfinance

What Is a Cash-Secured Put? Get Income or Cheap Stock

Cash Secured Put Chart
Cash Secured Put Chart

The cash-secured put is a risk-defined options trading strategy that involves the sale of a put option while holding funds on reserve to purchase the stock if/when assignment occurs.

The cash-secured put (also known as the cash covered put) options strategy is attractive to investors for two reasons: 

1.) The cash-secured put provides investors with a steady stream of income. 

2.) When/if assigned, cash-secured puts allow investors to purchase desirable stocks at a discount. 

The cash-secured put has a lot in common with the short (naked) put, with one major exception: the seller of cash-secured puts does not fear the stock falling in value, as it is their intent to purchase the stock at a discount via the exercise/assignment process

In an environment of constant volatility and price, options decay in value. This time decay, known as “theta” is advantageous to both short call and put options

Let’s first break this strategy down by looking at its profile.

 

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              TAKEAWAYS

 

  • The cash-secured put is a neutral to bullish options trading strategy.

  • In order for this trade to be “cash-secured”, the cost of the trade will be the cost to purchase 100 shares of the underlying stock at the strike price of the put sold.

  • The cash-secured put is an investment strategy that allows an investor to buy an attractive stock at a lower purchase price. 

  • If/when assigned, the short put will be replaced by 100 long shares of the underlying stock/ETF.

  • Traders who are very bullish on an underlying
     would be better off by simply buying the stock outright. 
Cash Covered Put

Market Direction

All Market Directions (depending on trade intent)

Trade Setup

Short 1 ATM/OTM Put Option 

Maximum Profit

1.) On the short put, max profit is the credit received.

2.) If assigned to stock, max profit is unlimited. 

Maximum Loss

1.) On the short put, max loss is strike price minus the premium received.

2.) If assigned to long stock, the max loss is unlimited. 

Breakeven Point

Strike price minus the premium received for the put.

Trade Cost (Margin)

Cash Account: (strike price) × (number of contracts) × (option multiplier)

Margin Account: Varies by broker (lower than cash account)

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What are Cash Secured (Covered) Puts?

The cash-secured put strategy has two components:

1.) Selling a put option contract

2.) Setting enough money aside to purchase stock at the strike price of the put should assignment occur. 

Determining the “moneyness” state of the put option you wish to short is subjective. Generally speaking, the strike price of put options sold in this strategy will be either:

1.) At-The-Money

2.) Out-Of-The Money

The cash-secured put is unique in that most traders of this strategy want their option to be assigned. This allows the stock to be purchased at a lower cost basis. 

However, even if assignment does not occur, the income from selling the put will still be collected, resulting in a win-win scenario. 

For example, if Ford stock (F), is trading at $15/share, and an investor wished to buy this stock at $13/share, that investor could sell the $13 put option at a later expiration cycle

If the stock closes above $13/share at expiration, the option will expire worthless. 

If the stock is trading below $13 at expiration, the short put will be assigned, and that investor will purchase 100 shares of F stock at the lower price of $13/share.

Cash Secured Put Risks

Risk #1:

We mentioned before that the cash-secured put is often a “win-win” trade. This does not mean that there is no risk in this options strategy

Most of the time, traders utilize this strategy when they want to purchase a stock at a discount from its current market price. If the stock price remains neutral, a trader will receive income from the option(s) sold. If the stock price declines below the strike price by expiry, that trader will purchase the stock at a better price.

But what if the stock is neither neutral or bearish, but bullish?

Cash Secured Put Chart

A trader could very well miss out on the price appreciation of a stock while waiting for it to fall in value, collecting only a relatively small amount of income from the put option sold

Risk #2

The second risk that the cash-covered put introduces pertains to the option itself. If a trader sells a $15 strike put, but that stock crashes to $10 in value, that trade will result in significant losses. Cash-secured puts are rarely sold on stocks that experience high volatility or this reason. 

Sure you’ll buy the stock for cheaper, but you’ll also lose a ton of money on the option. The “wait-and-see” approach is best for more volatile stocks. 

But enough theory, let’s see the cash-covered put in practice!

Cash Secured Put Trade Example

In this trade example, we are going to look at a cash-secured put on GoPro (GPRO). I prefer to use this strategy on cheap stocks. The cost of the trade is low, and if assignment occurs, it won’t eat up all your cash to hold the 100 shares.

Trade Details:

GPRO Stock Price: $8.40

Put Option Strike Price: 8

Credit Received: 0.25

DTE (Days to Expiration): 35

Breakeven: $7.75 (Strike Price – Premium)

Maximum Potential Profit: 0.25 ($25)

Maximum Potential Loss: $775 (Strike Price 8 – Premium 0.25)

 

We are next going to examine this trade through two different outcomes; one will be a desirable outcome, the next outcome will be less than desirable. 

Cash-Secured Put: Outcome #1

Trade Details:

GPRO Stock Price: $8.40 –> $7.50

Put Option Strike Price: 8

Put Value: 0.25 –> 0.50

DTE (Days to Expiration): 0

 

Cash Secured Put at expiration 5

In this trade outcome, the price of GPRO has fallen in value below the strike of our short put. If at the expiration date the stock price is below the short put strike, you will be assigned. The below image shows the exercise/assign process:

Assignment/Exercise Process

In The Money Option at Expiration

Here are the sequential steps that will happen to our GPRO trade if our option is in-the-money at expiration.

1.) The long party will exercise their long put option and receive -100 shares of stock; the short party (us) must therefore deliver this stock at $8/share. 

2.) Our short option is replaced by 100 long shares of GPRO stock for a cost of $800 (the true cost of this trade is $775 since the trade took in $25 in premium).

3.) If funds are not available to hold this stock, an account will be either placed in a margin call or liquidated. 

For cash-secured puts, the third outcome rarely happens. Why? Cash-secured means that a trader already has the funds placed on reserve to hold the stock. They are anticipating this to happen.

Cash-Secured Put: Outcome #2

Trade Details:

GPRO Stock Price: $8.40 –> $10

Put Option Strike Price: 8

Put Value: 0.25 –> 0

DTE (Days to Expiration): 0

In this trade outcome, the stock has risen well above our short strike price at expiration. This means there is zero chance of assignment. 

The good news? This trade collected the full premium of 0.25 ($25).

The bad news? We would have made a lot more money if we had just purchased the stock!

At the time of trade origination, the stock was trading at $8.40. At expiry, it was trading at $10/share. 

Had we just bought 100 shares of stock initially, we would have made $160 ($1.60 x 1 00) which is significantly less than the $25 we actually made. 

How Much Money Do You Need for a Cash Secured Put?

Cash-Secured Puts Trade Cost: (strike price) × (number of contracts) × (option multiplier)

For any account type, trading cash-secured puts is a costly endeavor. 

Cash-covered puts are backed 100% by cash. The cost of the trade is the cost to purchase the stock at the strike price. This means that if a stock plummets to zero, a cash-secured put trader already has those funds in their account to cover these losses. Let’s look at two examples:

➥AMZN: Short 2700 Put for $2 

amzn cash secured put buying power

So in this scenario, we must have the cash to purchase 100 shares of AMZN stock at $2,700/share. That’s a cost of $270,000. 

We can reduce the credit from this cost, but that credit is very small in the scheme of things, resulting in a true cost of $269,800

One of the great disadvantages of the cash-secured put is opportunity cost: what else could you be doing with that money? 270k is a lot of money to have on the sidelines! This is particularly true when you factor in the average return of the S&P 500 is over 10%/year.

That’s why cash-secured puts are usually sold on cheaper ETFs and stocks:

NOK: Short 4 put for $0.25

nok buying power

Sure you can only make $25 here, but the cash requirement for this cheap trade is only $400, or $375 when taking into account the option premium already received.  

Is a Covered Put the Same as a Cash Secured Put?

The cash-secured put is NOT the same strategy as the covered put.

While the cash-secured put is simply a short put option, the covered put option strategy consists of:

  • 100 Short Shares of Stock
  • Short One Put Option

The product of these two positions makes the covered put a bearish options strategy.

The cash-secured put is a neutral/bullish options strategy.

Additionally, the covered put strategy has unlimited risk, while the cash-secured put has defined risk. 

The below image shows the profit and loss of a covered put trade at expiration.

Covered Put Chart

Are Cash Secured Puts a Good Strategy?

So is the cash-secured put a good strategy? Like everything in options trading, that depends on the performance of the underlying!

If you are neutral to bearish in the short term, but bullish in the long-term, the cash-secured put is a great strategy to purchase an attractive stock or ETF at a discount. 

If you are bullish in the short-term, you best bet is to avoid this strategy and simply purchase the stock. 

Cash-Secured Put + Covered Call Strategy = The Wheel

Some traders like to utilize both the cash-secured put trade and covered call options strategy in sequential order. This is known as “The Wheel” options trading strategy

The Wheel strategy involves always being short an option. Once the short put is assigned, a trader would then proceed to sell a call against the long shares.

Here’s how that process works:

Can I Sell Put Options in My IRA?

The cash-secured put is a risk-defined trade and therefore permittable in both IRA accounts and cash accounts. 

However, just because the trade is allowed in these account types does not necessarily mean your broker will permit them.

Because of the risks that options trading introduces, many brokers limit or outright ban options trading in retirement accounts. 

However, a few trader-focused brokers, like tastyworks, allow options trading in IRA accounts.

The Best Brokerage for Traders

We’ve been trading with tastyworks for years, benefiting from their trader-friendly fees:

  • Free Stock Trading
  • $10 Commission-Cap Per Option Leg
  • Close Trades for Free*
  • $10 Max Fee Per Crypto Order

Sign up with tastyworks using the link below to secure a $200 free stock signup bonus.

* Applicable exchange, clearing, and regulatory fees still apply to all opening and closing trades except for cryptocurrency orders which are not subject to exchange, clearing, and regulatory fees.

Cash Secured Put vs Short Put

The cash-secured put is essentially the same trade as the naked put. The only difference is the cost of the trade.

Consider the cost of the below two short puts trades in FB, where one is done in an IRA account and the other done in a margin account:

 

Cash-Covered Put: Margin Account

Cash-Covered Put: IRA Account

As we can see, the cost of this trade is significantly higher in IRA and cash accounts than margin accounts. Why? IRA accounts don’t allow you to trade options on margin. 

One of the greatest risks that come with the cash-covered put is opportunity cost. What else could you be doing with that 20k while you are waiting to collect a small premium?

 

Cash Secured Puts FAQs

To close a cash-secured put, simply create the opposite order that was used to initiate the trade. If no action is taken and the cash-secured put is out-of-the-money at expiration, the short put will expire worthless. If the short put is in-the-money at expiration, the short put will be assigned 100 long shares of stock.

If the stock on which a put is sold increases in value, a short put option will decline in value, resulting in profits. If the stock is above the strike price of the put sold by expiration, the put option will expire worthless. 

The cash-secured put is a relatively safe strategy. At trade initiation, the full cost of the trade, or the maximum loss potential, is staked by the investor. This makes the cash-secured put a defined-risk trade. 

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Mike Martin

Mike Martin

Mike was a writer for projectfinance. He has spent over 15 years in the finance industry, working for such companies as thinkorswim, TD Ameritrade and Charles Schwab. His work has appeared in the Financial Times, the Chicago Sun-Times, and The Buffalo News.

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