Strategic Overview: What Is a Cash-Secured Put?
Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
A cash-secured put is an options strategy where a seller writes (sells) a put option while setting aside enough cash to buy the stock if assigned.
This strategy is suitable for investors with a neutral-to-bullish outlook, believing a stock may drop in price over the short term but increase in the long term. Some investors use cash-secured puts to buy a stock at a lower price, while others use the strategy to generate income from the option premium.
The Details of Selling a Cash-Secured Put
A put option gives the buyer the right to sell a stock at a specific price (the strike price) by a certain date. The seller takes on the obligation to buy the stock at that price if the option is exercised.
In a cash-secured put strategy, the seller collects a premium when the option is sold and sets aside enough cash to buy the stock if assigned. This approach is typically used to generate income or to acquire shares of a stock at a lower price. For a cash-secured put, sellers choose a put that is at- or out-of-the-money, such as one with a lower strike price than the current stock price.
Selling cash-secured puts is a moderately bullish options trading strategy that involves selling a put option with the expectation that it will either expire worthless or the underlying security temporarily drops in price, providing an opportunity for the seller to purchase the security at the lower price. In many cases, the seller hopes the stock will dip just enough for the option to be exercised, allowing them to buy the stock at a lower cost.
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What to Consider With Cash-Secured Puts
Cash-secured puts are geared towards sellers who want to purchase the underlying stock at a lower, predetermined price if the option is exercised. Sellers earn a premium immediately when they sell the cash-secured put. This strategy is typically used by sellers aiming to acquire a stock at a lower price if assigned, while also collecting a premium if the option expires.
If the market price of the security is lower than the strike price at the exercise date, the seller is obligated to purchase the security at the strike price — which, in the case of a cash-secured put, enables the seller to acquire the desired stock at a lower price. This happens only if the put buyer chooses to exercise the option early, which is uncommon but possible. There is a small risk of early assignment, which could require the seller to purchase the stock before the expiration date if the price drops significantly below the strike price. While uncommon, the put buyer can choose to exercise the option early, which would require the seller to purchase the stock before the expiration date.
If the market price of the security is higher than the strike price at the exercise date, the put option typically expires worthless, and the investor retains the premium. In this case, the seller has earned the premium amount and profited from the trade, as they say in options terminology. There is a rare but possible risk of early assignment, usually if the stock price falls sharply, which could require the investor to buy shares sooner than expected.
Sellers are required to have enough cash in their trading account to cover the full purchase amount. This cash amount must be kept in their brokerage account for the duration of time they hold the put, which is why it’s called a cash-secured put.
Some sellers write puts primarily to collect the options premium without intending to purchase the underlying stock. In these cases, they may write a naked put, which does not require holding cash to cover the purchase of the security, but does require sufficient margin in the account to meet potential obligations.
The seller would hope that the put expires without obligating them to buy, and they could pocket the premium amount. Cash-secured puts, again, are geared towards investors who actually want to purchase the underlying security on or before the exercise date at the price they chose when selling the put.
Cash-secured puts have both potential benefits and risks, and investors should evaluate whether this strategy aligns with their financial goals and risk tolerance.
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Pros & Cons of Cash-Secured Puts
Options strategies require the investor to be aware of multiple issues and cash-secured puts are no different.
What Are the Pros of Cash-Secured Puts?
Cash-secured puts offer potential income and the opportunity to buy stock at a lower price, but the strategy comes with some trade-offs. Sellers typically hope the stock dips just enough for the option to be exercised. However, if the price drops too far, the potential losses may outweigh the benefit of buying at a discount.
• The seller earns income from the initial premium paid, but may still incur losses if the underlying security’s price declines significantly.
• If the stock price is below the strike price at expiration, the seller will be assigned shares at the strike price, generally at a lower price than when the trade was initiated.
Note that if the stock price drops below the strike price and the shares are assigned, the investor will still pay the strike price for the shares. Be sure to think about what determines the stock price of the underlying security.
• If the price ends up increasing instead of decreasing, the put will expire worthless and the seller the premium and the cash set aside for the stock purchase.
• If a seller expects a short-term dip in stock price followed by long-term appreciation, cash-secured puts may offer a way to buy the stock below market value.
• If assigned, the seller’s long-term gains from holding the stock could be significant, even though the option premium itself is capped.
Recommended: Learn About the Greeks in Options Trading
What Are the Cons of Cash-Secured Puts?
While cash-secured puts can offer strategic advantages, they also come with potential risks and trade-offs that sellers should consider carefully.
• The security might drop below the strike price and, in extreme cases, could even fall to $0. Although rare, corporate bankruptcies do occur. In this case, the investor would still be obligated to purchase the security at the higher strike price, and would then hold a worthless security. However, even if the security plummets, the investor would still earn the premium amount, and their losses would be less than if they’d simply purchased the security instead of selling the put option.
• When entering the trade, the investor must be prepared to accept the strike price no matter what happens in the market before the exercise date.
◦ Maximum loss = (strike price – $0) x 100, minus any premium received
◦ Maximum gain = premium amount
◦ This assumes the seller is assigned and the stock becomes worthless. This is unlikely but possible (e.g.,if the company goes bankrupt)
• A cash-secured put allows the investor to wait for a dip in the security’s price. If the stock price does not drop to the strike price before expiration, the put option expires worthless, and the investor does not acquire the stock. At that point, they will decide whether to buy at the current market price or pursue a different trade.
If a seller knows they want to purchase the security they may want to consider other investing strategies or simply purchase the security at the current market price instead of using the cash-secured put strategy.
• The seller must hold enough cash to cover the cost of the security for the duration of the trade. This means they can’t invest that cash into other trades.
• From a short-term perspective, the potential losses from a cash-secured put option trade are high and the potential gains from the put option itself are low.
Tips for Employing a Cash-Secured Put Strategy
There are several ways to refine a cash-secured put strategy based on market conditions and individual goals.
• If a seller is bullish on a security, they should choose an out-of-the-money put option with a strike price below the current market price of the stock.
• When a seller sets a strike price that is far out-of-the-money, they receive a lower premium and the option is less likely to be exercised.
• Sellers who are very bullish on a security in the short term should choose other investing strategies. Cash secured-put options are best if the investor has a neutral to slightly bullish view of the security.
• It’s best to sell cash-secured put options when implied volatility of a security is high, because this results in higher option premiums. One way to find securities with high implied volatility is to look for stocks that have recently declined. Some price drops may be short-term, but it’s important for sellers to research whether a stock is more likely to bounce back before using this strategy.
• Due to the risk of a security’s price dropping more than the investor expects in the short term, it’s best to only sell put options for companies that the investor has researched.
• Investors generally sell puts with 30-90 day time frames, though some investors choose to sell weekly put options.
The Takeaway
Cash-secured puts are one possible way to generate income while an investor waits for a stock to drop to their desired entry price. Selling cash-secured puts is a moderately bullish options trading strategy that involves selling a put option with the hope that it either expires, or the underlying security temporarily drops in price and lets the investor purchase the security at the lower price.
Although this strategy is not without risk, it can allow the investor to generate short-term income on the sale of the put, set the price (strike price) at which they will buy the stock if assigned, and enter a stock position at a lower price than when the trade is initiated.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
Photo credit: iStock/Vanessa Nunes
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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