Cash Secured Puts: Everything You Should Know

Want to get a stock at a lower cost basis? Some options traders use cash-secured puts to achieve that objective. Under certain conditions, you can receive the premium and acquire stocks at the same time. Cash-secured puts can be used to potentially buy shares at a lower cost basis. This article will explore how cash-secured puts work, their potential advantages and some things to keep in mind before getting started.

What Are Cash-Secured Puts

Options traders can trade calls and puts. Puts gain value when the underlying stock’s price goes down, but if a put never hits its strike price, the contract expires worthless. Some options traders prefer to sell puts and collect premiums, usually hoping that puts will expire worthless. That scenario plays out if the stock price does not fall below the put’s strike price. If a stock’s price falls below the strike price, you will have to buy 100 shares of the stock at the designated strike price. This purchase takes place at the strike price regardless of the current market price.

Maximum Profit

Do you wonder what it takes to profit from options trading? The maximum profit

depends on the type of contract. For cash-secured puts, the maximum profit is the

premium. If you sell a put and obtain $300, that’s the maximum amount you can gain. To achieve this gain, the put must expire worthless. If a stock is valued at $90 per share, and an options trader sells a put with an $85 strike price, that trader will hope for the stock to stay at $90 per share or go up in value. It’s OK if the stock falls to $86 per share. But if it falls below $85 per share, the put contract holder can force you to buy 100 of their shares at $85 per share.

Maximum Risk

The maximum risk is similar to the risk with any investment. Maximum potential loss can be substantial, which is the strike price if the underlying stock price goes down to zero. The premium will help offset some of your losses if you incur any.

Maximum risk rarely plays out, but Silicon Valley Bank demonstrates how cash-

secured puts can go wrong. The bank’s collapse came as a surprise, and people with money beyond the Federal Deposit Insurance Corp. (FDIC) coverage suddenly saw their capital evaporate. Investors holding onto cash-secured puts also saw their capital evaporate from those positions. This scenario rarely happens, especially if you pick blue-chip companies. It also demonstrates the type of downfall the underlying stock would have to experience to end up with the maximum loss on a cash-secured put.

Break-even Stock Price at Expiration

The break-even stock price at expiration is the difference between the strike price and premium. If you sell a cash-secured put with a $45 strike price and receive a

$3 per share premium ($300 total), your break-even price is $42 per share — $41.99 represents a loss, while $42.01 represents a profit.

Potential Profit or Loss

It’s possible to profit from a cash-secured put even if you have to buy 100 shares at the agreed-upon strike price. In the previous example, with a $45 strike price, you can secure a profit if the stock price is between $42.01 and $45. You won’t make a full profit, but it won’t show up as a loss.

If the stock trades at $43 per share at expiration, and you have to buy 100 shares at $45 per share, you will lose $200 on that transaction, or $2 per share. But the $300 premium ($3 per share) balances out the loss and allows you to close the position with a net gain.

If the stock closes at $41 per share, you will lose $4 per share when the order gets executed. The $3 per share premium compensates for some of those losses, lowering it to a $1 per share net loss instead of a $4 per share net loss.

How Do Cash-Secured Puts Work

You have to put money down to sell a cash-secured put similar to a secured credit card or certificate of deposit. The amount you have to put down depends on the strike price. If you sell a cash-secured put with a $70 strike price, you must put down enough capital to buy 100 shares at the strike price. In this example, you need $7,000 for a cash-secured put ($100 x 70 = $7,000).

You cannot use the capital for any other investment until the cash-secured put expires. Upon expiration, the contract will be worthless, or you will have to purchase 100 shares. A put loses value if the stock’s price stays the same or goes up. Time decay is another contributor to a put’s decline, which is why puts near expiration have lower premiums.

If you want to access the money you put down earlier, you would have to buy to close the cash-secured put.

What Is the Motivation for Cash-Secured Puts

There are two motivations for cash-secured puts. Some option traders want the

stock’s price to rise while they hold onto the put. The put’s value will deteriorate under these circumstances and let the trader keep the premium. The trader can then use their capital at expiration to enter another cash-secured put.

Some investors wouldn’t mind getting assigned and hope to buy 100 shares at the agreed-upon strike price. If you are adamant about a $100-per-share stock only being worth $80 per share, you can sell a cash-secured put with an $80 strike price and collect the premium. If the stock falls below $80 per share, you get 100 shares at what you saw as fair value plus the premium. If the stock does not fall below $80 per share, you still get the premium.

Cash-Secured Puts Explained

Many brokerage firms let you sell cash-secured puts. You will need enough cash to buy 100 shares at the strike price. After accumulating enough cash and putting it in your brokerage account, you can start a cash-secured put. A trader would have to “sell to open” a put.

The sell-to-open order initiates the cash-secured put, and you will get the premium right away. You can use this premium to buy shares or hold onto it. You can get out of acash-secured put by waiting for it to expire worthless if it’s OTM, waiting for it to get exercised if it’s ITM at expiration, or buying back the put to close the position. Your broker will let you select buy to close for the latter choice.

Potential Advantages of Cash-Secured Puts

Cash-secured puts provide several advantages for traders and investors:

• Get the premium right away: You can use the premium to buy additional shares or put it in a high-yield account upon initiating the cash-secured put. You don’t have to wait for the contract to expire before using these proceeds.

• Lower your cost basis: If you end up buying 100 shares, you will get them at a lower cost basis. Your cost basis is the strike price minus the premium, not just the strike price.

• Potentially buy stocks at lower price: If you believe a stock is overvalued, you can sell a cash-secured put with a strike price that you believe represents fair value. You get paid while you wait.

Things to Consider with Cash-Secured Puts

Cash-secured puts have risks, just like any other investment. The two main risks with cash-secured puts are opportunity cost and a declining stock price. Initiating a cash-secured put requires putting some of your money on the sidelines. You cannot use the secured funds to make additional investments or capitalize on another trading opportunity.

The other risk is if the stock price declines. Your strike price of $45 may look good if the stock’s price is $50, but it’s possible for the stock to fall to $30 per share. A trader would lose $15 per share in this scenario. Investors may want to sell cash- secured puts for stocks they wouldn’t mind owning for the long term to account for potential price volatility.

There is also the risk of the stock never being assigned and it increases in value. In that scenario, the investor who wanted the stock misses out on that potential gain.

How Can Cash-Secured Puts Help?

Cash-secured puts offer immediate cash flow and the potential to buy shares at a lower cost basis. Premiums act to lower your cost basis if you end up with the shares. It’s also possible that the put contract expires worthless, and you end up with the premium. You can then reload with your available capital or wait for another opportunity to emerge. Traders and investors who use options can tap into more opportunities for potential portfolio growth.

Frequently Asked Questions About Cash-Secured Puts

1. Are cash-secured puts a good strategy?

They can be a useful strategy to get premiums and potentially buy stocks at lower cost basis.

2. Can you make money on cash-secured puts?

Yes. The premium represents your maximum profit.

3. When to consider cash-secured puts?

The stock market typically presents potential opportunities to investors, but yo should only sell cash-secured puts when you feel confident in the setup. It’s generally a good idea to sell cash-secured puts for stocks you wouldn’t mind owning.