Details on Selling Cash Secured Puts
In the cash secured put strategy you need to have some cash in your brokerage account. How much? Enough to buy the shares you would be obligated to purchase at the specific strike price you sold the put. Remember 1 put controls 100 shares of stock. So if, for example, you are selling 1 put at a $20 strike price, then you will need $2000 in you account to secure the sale. What does “sell a put” mean? This means you instruct your broker to sell a put at a specific strike price for a specific time duration. You will immediately pocket the premium when the put is sold. Remember that as an option seller you are paid this premium because you take on an obligation to purchase the stock from the put buyer if he exercises the option anytime before expiration. By having enough cash in your account to purchase this potential stock, you have the ability to sell a “Cash-Secured Put” . (For future reference: You can sell puts without complete cash coverage if you open a margin account. But you will need proper permission to do so from your broker. When beginning, you should sell cash-secured puts). You will want to carefully consider at which strike price and for what time duration you will want to sell the put. You will want to sell an out-of-the-money put that will expire with the next month. Why is that? Because you will not likely be put the stock unless the stock price falls below the strike price. Select a low enough strike price and that likelihood is minimized. If the price of the stock is greater than the strike price of the option at the time of expiration (the third Friday of the month), then the premium is yours free and clear.
What if the stock price falls below the strike price of the put you sold? If this occurs you will need to take defensive action - probably getting out of the position at a loss - unless you don’t mind at all owning the stock at that price.
Let’s Look at an Example: Remember Phoebe from Phoebe, Craig and Mary? Let’s say she has accumulated $20,000 in her brokerage account. XYZ is currently at $10/share. She has been eyeing the options tables for XYZ and sees that she can sell next month’s $5.00 strike-price XYZ put for $0.25. Because she has $20,000 in idle cash she can afford to sell up to 40 puts. She has noticed that XYZ has stayed in a range above $5/share for the last two years. She likes her odds on this strike price and decides to sell 10 contacts of next month’s XYZ 5’s, using one-quarter of her idle cash to secure this put sale. Let's do the math: Sell 10 Puts at $0.25. 10 Puts x 100 shares/put x .25/put = $250 premium received (before commissions). If XYZ is above the strike price at expiration: She keeps the $250 and has generated this in about one month’s time If XYZ is below the strike price at expiration: She will be automatically buy 1000 shares XYZ at $5/share
Some Considerations to Think About When designing a cash secured put selling program for income generation would you mind being forced to buy the stock at the strike price or not? If you don’t want “to be put” the stock then you will need to consider selling puts at strike prices that are sufficiently out-of-the-money that that they are unlikely to be reached. Remember what we learned in Reading Options Tables: The farther out-of-the-money the less you will receive in premium. So, safer put sales (that is sold puts that are unlikely to be exercised) will generate less premium income than put sales with strike prices closer to the current price of the stock. You can increase your premium income for the same strike price by selling puts that are further out in duration (say, for example, 2 to 3 months out). This will, of course, decrease the frequency of you periodic income, but each put sale will generate a higher payout in premium. Take a look at an options table for particular stocks you follow and see. What can go wrong? As in the case with covered calls, there are downside risks to cash secured put sales. The principal risk is a Big Downward Price Move in the underlying stock, such that the stock price dives below the strike price of the put sold. This places you at risk of being assigned the stock. We will be designing cash secured puts with several considerations in mind. If you don’t mind owning the underlying at the strike price then you have nothing to worry about. In fact, many people sell puts with that very intention of buying stock at a lower-than-current price, and being paid to do it. If, however, you are only interested in generating income, and are not wanting to own the stock, then you will need to monitor the price of the stock versus the strike price at which you sold the put. If the stock price falls below the strike price you risk assignment and you will want to get out of the sold put position, sometimes at a loss. More on that in the Step-by Step Guide. One other point to be aware of: you can be put the stock at anytime during the lifetime of the put option if the price of the underlying stock falls below the strike price. This can and does happen, but most assignments will occur on the 3rd Friday of the month at the end of the option’s life. Additional Resources:
The cash secured put sale is a commonly used options strategy. You can read about it from many other sources. I can recommend the following link for more information:
More info on Cash-Secured Puts
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