Options Strategies: Cash Secured Put

Learn more about how to strategize a cash secured put, and open your account on 1455’s powerful options trading platform.

The covered call strategy is when an investor writes a call contract while owning a significant amount of the underlying stock. If the stock is purchased at the same time as the call contract is written, then the strategy is often called “buy-write.” If the stock was previously purchased, then the strategy is often called “overwriting.” In both cases, the stock used is usually in the same economic account where the investor wrote the call contract. These stocks are fully collateralized for the obligation contained in the written call contract. This is also called “covering.” This strategy is the most basic and widely used strategy to take advantage of the flexibility of listed options and stock ownership.

When to use?

Although the covered call strategy can be used in any market situation, it is more often used when the investor is bullish on the underlying stock and believes that the stock price will change little during the life of the call contract. The investor either wants to obtain additional income from the underlying stock beyond dividends, or (at the same time) provide limited protection against a decline in the underlying stock price.

benefit?

This strategy provides limited protection from a decline in the underlying stock price and limited profit opportunities from an increase in the stock price. But the benefit it generates is the premium the investor receives from writing the call contract. At the same time, if the investor is not assigned an exercise notice for the written call and is forced to sell his stock, he still retains all the benefits of ownership of the underlying stock, such as dividends and voting rights. Because covered calls reduce the risk of stock ownership, this strategy is widely considered to be a conservative one.

Risks and benefits?

Maximum loss: Purchase price of limited shares – Strike price + Premium paid(Premium Received)

Maximum Loss: Substantial (Strike Amount – Premium Received)

Upside Profit at Expiration: Premium Received from Put Sale

Net Stock Purchase Price if Assigned: Strike Price – Premium Received from Put Sale

If the underlying stock increases in price and the put expires with no value, the profit is limited to the premium received from the put’s initial sale. On the other hand, an outright purchase of underlying stock would offer the investor unlimited upside profit potential. the underlying stock declines below the strike price of the put, the investor of this put option trading strategy might be assigned an exercise notice and be obligated to purchase an equivalent number of shares. The net stock purchase price would be the put’s strike price less the premium received from the put’s sale. This price can be less than the current market price for the stock when the cash secured put assignment is made.

The loss potential for the cash secured put is similar to owning an equivalent number of underlying shares. Theoretically, the stock price can decline to zero. If the cash secured put assignment results in the purchase of stock at a net price greater than the current market price, the investor would incur a loss—unrealized, as long as ownership of the shares is retained.

Break-Even-Point (BEP)?

BEP: Strike Price – Premium Received from Sale of Put

Volatility

If Volatility Increases: Negative Effect

If Volatility Decreases: Positive Effect

Any effect of volatility on the cash secured put’s total premium is on the time value portion.

Time Decay?

Passage of Time: Positive Effect

With the passage of time, the time value portion of the option’s premium generally decreases—a positive effect for an investor with a short option position.

Alternatives before expiration?

If the investor’s opinion about the underlying stock changes before the put expires, the investor can buy back the same contract in the marketplace to “close out” his position,thereby realizing a gain or loss. After this is done, no assignment is possible. The investor of this cash secured put strategy is relieved from any obligation to purchase underlying stock.

Alternatives at expiration?

If the short option has any value when it expires, the investor will most likely be assigned an exercise notice and be obligated to purchase an equivalent number of shares. If owning the underlying shares is not desired, the investor can close out the written put by buying a contract with the same terms in the marketplace. Such a purchase would have to occur before the end of market hours on the option’s last trading day, and could result in a realized loss. On the other hand, the investor is obliged to take delivery of the underlying shares at a possible unrealized loss, in the event of assignment.

We hope this guide to cash secured put strategies has been helpful to you. See our next lesson on bull call spreads here. Open your online trading account today!