Cash secured put options strategy is a popular investment technique that involves writing a put option and simultaneously setting aside the cash to buy the stock if assigned. This strategy is suitable for investors who are bullish about a particular stock in the long term but expect it to drop in the short term. The cash-secured put option strategy allows investors to buy the stock at a price below its current market value, provided the put is assigned.
To execute this strategy, an investor writes an at-the-money or out-of-the-money put option and sets aside enough cash to buy the stock. If the stock price remains unchanged or rises, then the price of the put will decline. In return for receiving a premium, the seller of a put assumes the obligation to buy the underlying stock at the strike price at any time until the expiration date. Typically, stock options in the U.S. cover 100 shares, so the investor receives a premium per share and assumes the obligation to buy 100 shares of the stock at the strike price until the expiration date.
For example, an investor can sell one XYZ 100 Put at $3.00 per share ($300 less commissions) and hold cash (or money market account) of $97.00 per share ($9,700 for 100 shares). If the put is assigned, the investor can use the net premium received to purchase the shares along with the cash deposited in a money market account.
One of the benefits of selling a cash-secured put is that if the stock is purchased because the put is assigned, then the purchase price will be below the current price. Additionally, selling a put brings in a premium (cash) which is kept as income if the put expires worthless. However, the profit potential is limited, and if the stock price rises sharply, then the short put profits only to the extent of the premium received.
The downside of cash-secured puts is that the income generation strategy is not suitable for investors who need to eventually own shares of the underlying company. If the share price stays higher, the investor may never own shares. Also, the possibility of early assignment should not be of great concern since sellers of cash-secured puts are generally willing to buy the underlying shares. Early assignment of a cash-secured put simply means that stock is purchased before the expiration date.
To receive a desirable premium, a time frame to shoot for when selling the put is anywhere from 30-45 days from expiration. This will enable investors to take advantage of accelerating time decay on the option’s price as expiration approaches and hopefully provide enough premium to be worth their while.
In conclusion, the cash-secured put options strategy is a useful tool for investors who are bullish about a particular stock in the long term but expect it to drop in the short term. It allows investors to buy the stock at a price below its current market value, provided the put is assigned. While there are potential downsides to this strategy, such as the possibility of never owning shares, the benefits of selling a cash-secured put outweigh the risks. Investors must make a subjective decision between buying the stock today and selling a cash-secured put today and holding cash in reserve.