How cash secured put works

A cash secured put is an options strategy where an investor writes (sells) a put option and simultaneously sets aside enough capital to buy the underlying shares if the option is a

A cash secured put involves selling a put option and holding an equivalent amount of cash in your brokerage account as collateral, ensuring you can purchase the underlying stock if the option expires in the money and you are assigned. When an investor sells a put option, they collect a premium upfront. The strike price of the put represents the price at which the seller agrees to buy the shares if the option is assigned. The expiration date defines how long this agreement is valid. If the stock price remains above the strike price until expiration, the put option expires worthless, and the seller keeps the entire premium as profit, without buying any shares. However, if the stock price falls below the strike price by expiration, the put option is in the money, and the seller is obligated to buy the shares at the strike price. The 'cash secured' aspect means that the investor has already reserved the necessary funds to make this purchase, reducing the risk of a margin call or a forced liquidation of other assets. This strategy is often employed by investors who are bullish or neutral on a stock and are willing to own it at a specific price, viewing the premium as an attractive return. It can also be seen as a way to acquire shares at a discount if the stock price drops. The premium received directly reduces the effective purchase price of the stock if assignment occurs. The cash secured put influences options prices by adding supply to the market for put options at a specific strike price, which can subtly affect implied volatility and the bid-ask spread for those contracts. The demand for these options from buyers seeking downside protection intersects with the supply from sellers like those employing cash secured put strategies, helping to establish the current market price for the option.

Why it matters

Common mistakes

- One common mistake is selling a cash secured put on a stock one is unwilling to own for the long term. This can lead to being stuck with shares of an undesirable company if assigned, rather than benefiting from the strategy's intention.
Another error is choosing a strike price too close to the current market price without strong conviction that the stock will stay above it. This increases the likelihood of assignment and can result in premature ownership when the market sentiment is turning negative.
Investors sometimes fail to account for the opportunity cost of having capital tied up as collateral for the cash secured put. This reserved cash cannot be used for other investments, which might be a better use of funds if the market conditions change unexpectedly.
Over-leveraging by selling too many cash secured puts relative to one's available capital is a significant mistake. While the strategy is 'cash secured,' over-committing can still lead to financial strain if multiple assignments occur simultaneously, especially during a broad market downturn.

FAQs

What happens if the stock price stays above the strike price at expiration?

If the stock price remains above the strike price at expiration, the put option expires worthless. The seller keeps the entire premium collected when selling the put and has no further obligations, effectively generating income from the trade.

What is the maximum profit potential of a cash secured put strategy?

The maximum profit potential of a cash secured put strategy is limited to the premium collected when the put option is sold. If the option expires worthless, this premium is retained as pure profit.

How does implied volatility affect the premium received for a cash secured put?

Higher implied volatility typically results in a higher premium received for selling a cash secured put. This is because options prices are more sensitive to expected price swings, making the potential for the option to expire in the money greater, and thus demanding a larger premium from buyers.