What is a cash secured put?
A cash secured put is a type of option strategy in which an investor sells a put option on a stock or other underlying security, but has enough cash in their brokerage account to buy the shares if the option is exercised. This is called being “cash secured” because the investor has the cash available to fulfill their obligation to buy the underlying shares if the option is exercised.
The investor collects a premium from the sale of the put option, but is also taking on the risk that the stock price will decline below the strike price of the option. If the stock price declines below the strike price, the option will likely be exercised and the investor will be required to buy the underlying shares at the predetermined strike price. If the stock price continues to decline, the investor may incur a loss on their investment.
Cash secured puts can be a useful strategy for investors who are bullish on a stock or other underlying security, but want to collect a premium from the sale of the put option. However, it is important to carefully consider the potential risks and rewards of this strategy before implementing it.
Example of a cash secured put strategy:
An investor is bullish on Apple (AAPL) stock and believes that the price will not decline significantly in the near term. The current price of AAPL stock is $140, and the investor decides to sell a put option with a strike price of $140 that expires in one month. The investor collects a premium of $2 per share for selling the put option, or $200 in total (assuming the option covers 100 shares).
Now, the investor has to wait until the option expiration date to see if the option will be exercised. If the price of AAPL stock remains above $140 at the expiration date, the option will expire worthless and the investor will keep the $200 premium. However, if the price of AAPL stock declines below $140, the option will likely be exercised and the investor will be required to buy 100 shares of AAPL at $140 per share, or $14,000 in total.
If the price of AAPL stock continues to decline after the investor buys the shares, they may incur a loss on their investment. However, if the price of AAPL stock rises, the investor may be able to sell their shares at a higher price and potentially profit from the stock appreciation. Overall, the potential risks and rewards of a cash secured put strategy depend on the performance of the underlying stock.
How to choose the strike price?
One way to approach the selection of options to trade is to focus on delta values. Delta is a measure of the sensitivity of an option’s price to changes in the price of the underlying security. Delta values can range from 0 to 1 for calls and -1 to 0 for puts. Generally, options with a delta value close to 0.25 are considered to have a lower probability of being exercised, making them a good choice for selling cash secured puts or covered calls. Robinhood, a popular online brokerage platform, provides a “Chance of Profit” column that can help investors determine the likelihood of an option being exercised. This column is not the same as the delta value, but is derived from the delta value. Investors can use both the delta value and the “Chance of Profit” column to help make informed decisions when selecting options to trade.
Selling a put to buy a stock you like
Selling a put option is a strategy that can be used to buy shares of a stock that you like at a predetermined price. This strategy involves selling a put option with a strike price that is below the current market price of the stock. If the stock price remains above the strike price at the option expiration date, the option will expire worthless and you will keep the premium you received from selling the put option.
However, if the stock price declines below the strike price, the option will likely be exercised and you will be required to buy the underlying shares at the predetermined strike price. This can be a good way to buy into a stock that you like at a lower price than the current market price. For example, if you like a stock that is currently trading at $100, you could sell a put option with a strike price of $90. If the stock price remains above $90, you will keep the premium you received from selling the put option. However, if the stock price declines below $90, the option will likely be exercised and you will be required to buy the shares at $90 per share. This can be a good way to buy into a stock that you like at a lower price than the current market price.
Risk of selling put options
The main risk of selling put options is that the stock price may decline below the strike price of the option, in which case the option will likely be exercised and you will be required to buy the underlying shares at the predetermined strike price. If the stock price continues to decline after the option is exercised, you may incur a loss on your investment.
Another potential risk of selling puts is that the stock may not perform as well as expected, resulting in a lower premium for the option. This can reduce the potential profit from the put selling strategy. Additionally, there may be additional trading costs associated with selling puts, which can further reduce potential profits.
Overall, the risks of selling puts include the potential for a loss on the purchase of the underlying shares, lower premiums for the option, and additional trading costs. It is important to carefully consider these risks and consult with a financial advisor before implementing this strategy.