What is a Cash Secured Put?

A cash secured put is an agreement between you and a stock holder. You are agreeing to purchase a certain amount of shares of the underlying stock at a certain price on a certain date. In exchange for you guaranteeing to purchase the shares the stock holder will give you a premium.

Lets take an example. You decide that you want to open a position in ABC. Currently ABC is trading at $10 per share. You sell a put that expires in 28 days at $10. In exchange for agreeing to purchase the shares at $10 you get a premium of $.50. Now keep in mind that each put you sell is an agreement to buy 100 shares. This means that the $.50 premium you receive is per share, or $50; and the stock you are agreeing to buy is $1000 worth of stock. So you will need to put up $950 as collateral in this case. The $50 premium you receive will cover the remainder of your collateral. In this example there are two outcomes to the trade.

Outcome One

The first outcome is that the stock price will close above $10 at the end of the 28th day and the option will expire worthless. If this happens then you get to keep 100% of the option premium and can open up a new position if you wish.

Outcome Two

The second outcome is that the option expires in the money, which means that the stock price closes under $10 at the end of the 28th day. If this happens you will be assigned the shares at $10 per share. The strike price of the contract. Once you own the shares, you can start selling covered calls. To learn more about covered calls check out our article here.

You can also roll or close the contract before the end of the 28th day. You can choose to roll it forward for a credit, or buy it back at a lower price.

What are the negAtives of cash secured puts

The biggest negative to cash secured puts are opportunity cost. Lets use the above example again. Lets say you really want to purchase stock ABC at $10 per share. The stock finally comes down to your price and you open a cash secured put 28 days out. When you open this position you need to realize that the stock may go back up to $11 or $12 during that time period. Now, you will get to keep the premium, but you will have to wait for the stock price to come back down to your target.

The other big negative to this strategy is you are locking in your price potentially weeks out. So, if the stock price drops significantly during this timeframe, you will either have to close the position at a loss or have the shares assigned to you at a higher price. Now, in all honesty this really shouldn’t be a negative since you are choosing the stock price, the expiration date, and the share quantity.

Selling cash secured puts can be a great way to either generate income inside of your portfolio, or lower your cost average on a potential position. You do need to have the cash to use as collateral, so this strategy can be capital intensive as you are required to purchase sets of 100 shares. But, if used correctly then this can be a great strategy to add to your investing tool belt .