Managing Cash-Secured Puts for Income Strategies

Designed to generate short-term income or purchase desired stocks at a favorable price, writing cash-secured puts is a bullish strategy. Traders sell out-of-the-money (OTM) put options on stocks they consider to be good buys at lower prices, with enough money in their account to cover the purchase. If the option stays OTM, then the trader collects the premium for writing the put. If the option is exercised, then the trader has enough cash to buy the shares.

Many traders find writing cash-secured puts to be a moderately conservative strategy relative to buying stock outright. As with any strategy, traders should understand how it works and what the risks are before placing their first order. While the ideal candidate is a stock you'd be comfortable owning at the right price, the trigger for a lower price could be a fundamental change that makes the stock much less attractive. 

A cash-secured put strategy may be a good way to start trading options within a long-term equity portfolio. But it carries risk. 

A long put is a contract that gives the holder the right to sell the underlying stock at a pre-determined price. A short put creates an obligation to purchase the underlying stock at the strike price. If a put is cash secured, then the put seller has enough money in their account to cover the cost of the stock purchase if the option is assigned to them. 

In a typical cash-secured put trade, the trader sells a put to collect premium. If the put expires OTM, they keep the premium and the option typically expires worthless. If the stock closes below the put strike price at expiration, the trader will likely be assigned, resulting in buying 100 shares of stock per standard contract at the strike price. Remember, being short an in-the-money (ITM) option at expiration increases your likelihood of assignment; however, it does not guarantee it. The primary objective is to generate income from writing the put, and a secondary objective is to buy the stock at a comfortable price level for the trader.

Cash-secured puts can be a good strategy if a trader is willing to buy a stock that they're bullish about in the long term but think it might experience a short-term correction. Keep in mind, a big drop in the stock price might force a trader to buy the stock well above the market price at the time of assignment. And while the trader might be unhappy with that outcome, they'd be no worse off than if they had already owned the stock. 

Stocks that form the basis of a good cash-secured put transaction tend to be those on which a trader is neutral or bullish. Remember, this is considered a bullish strategy. After all, if a trader wasn't bullish on the stock, they likely wouldn't want to risk being assigned and end up owning it.

Here's an example. Let's say a stock is trading at $52. A trader can sell a put option with a strike price of $50 for a $2 premium. If the stock price is above $50, the trader gets to keep the premium, which would be worth $200, excluding commissions, because the multiplier for a standard options contract is 100. If the stock price closes below $50 at expiration, the trader may be assigned. This means they'll have to buy the stock at $50 per share, no matter what the market price of the stock may be. The money will come from the cash account that secured the put purchase, so the trader will need to have at least $5,000 set aside. Because the trader gets to keep the $2 premium, they'll have an unrealized profit as long as the stock price is above $48. Below $48, they'll have an unrealized loss, but the loss is less than if they had purchased the stock instead of selling the OTM put.

You might notice that the payoff of the options position is the same as for a covered call. The maximum gain for the cash-secured put is the premium received from selling the put. The maximum loss, however, is limited but significant—it's comparable to owning the underlying stock. The break-even point for this strategy is equal to the strike price minus the premium received.

Because the premium received in essence reduces the purchase price, some traders write cash-secured puts that are near the money as an alternative to buying stock. However, the stock could increase in price, and therefore, a trader may not be assigned at their lower strike price. If they have a strong bullish conviction on the stock and don't like the idea of missing out on a potential move higher, they may be better off buying the stock outright instead of selling a put. 

If the trader sells OTM cash-secured puts and the underlying stock remains relatively stable or increases in value, the options will eventually expire worthless. Sometimes, however, the stock may end up very close to the strike price or go down enough to end up ITM. What the trader will choose to do next depends on whether their opinion about the stock has changed. Are they more or less bullish? Or perhaps they turned bearish? Let's explore possible alternatives. 

If the underlying stock has remained relatively flat or increased slightly, the trader's cash-secured puts may be OTM as the expiration date approaches. In this situation, the course of action may be to let the OTM cash-secured puts expire worthless. When this occurs:  

• The put option(s) will be automatically removed from the account. 
• The net credit from the original sale of the options will be retained in the account with no further obligation. 
• This is the maximum profit that can be earned on cash-secured puts.

At this point, if the trader is still at least moderately bullish on the underlying stock, they can sell, or roll, new cash-secured puts for a later month; if not, the trader is done. 

If the cash-secured puts expire ITM (meaning the stock price closed below the put strike price) and a trader does nothing, they will most likely be assigned and required to purchase the underlying stock at a price equal to the strike price of the put minus the premium received when the put was sold. This could occur prior to expiration but usually happens at or very near the expiration date; unless the trader has become bearish on the stock, this may be an acceptable outcome. 

If the cash-secured puts are only slightly ITM, this is usually a good thing. This suggests a trader will be purchasing a stock on which they were bullish, at a price originally deemed favorable, and their overall net cost basis will actually be lower than the strike price. In other words, the options premium helped subsidize the stock purchase.

If the cash-secured puts expire deep ITM (meaning the stock price dropped substantially), a trader's net cost basis will likely be higher than the stock's current market price. While the trader could have an unrealized loss at this point, their overall basis will still be lower than if they had purchased the stock on the day they originally sold the cash-secured put(s). When a trader is assigned, the cash-secured puts will be automatically removed from their account and the underlying stock position will be placed in their account. Their account will be debited by the amount equal to the purchase of the stock at the strike price of the put option. 

Sometimes options assignments occur prior to expiration. While this is somewhat rare for cash-secured puts, it's more likely to occur if the underlying stock pays a dividend. Options prices are not adjusted for normal quarterly dividends. As a result, an owner of protective long puts that has become bearish on the stock may decide to exercise the puts on the ex-dividend date in order to sell the stock but receive the very last dividend payment. This generally happens when the put options are ITM and the amount of the dividend exceeds the remaining time value in the options, or if the bid price of the options has dropped below the intrinsic value. 

This incentive exists because the strike price the put owner will receive for the stock is the same before or after the ex-dividend date. However, if the owner waits at least until the ex-dividend date, then they'll be the owner of record when the next dividend is paid. While this risk is relatively small, if a trader intends to sell cash-secured puts on dividend-paying stocks, they need to take note of the ex-dividend dates. 

Let's say a trader sold cash-secured puts on a stock and the stock price rises faster than they expected. However, the trader is concerned the price may come back down before expiration. One course of action may be to close out the put(s) by buying them back in the market, which under these circumstances can usually be done at a net profit.

If the trader has chosen to sell a cash-secured put on a dividend-paying stock and the options are ITM as the ex-dividend date approaches, they can sometimes avoid early assignment by buying back the put before the ex-dividend date at either a gain or a loss. 

Keep in mind that as a cash-secured put seller (writer), the trader has assumed an obligation to buy the underlying stock any time the put owner (buyer) chooses. While early assignments generally occur on the ex-dividend date, they can happen any time a put goes ITM. 

If a cash-secured put goes ITM any time prior to expiration and the trader simply wants to avoid further losses, they can usually close out the cash-secured put by buying it back in the market, usually at a loss.

While a trader will want the stock to go up in price, if that happens, the option declines in value. Because the option is now cheaper, it may make sense to repurchase the option to take the risk off the table or roll it into a new position.

In the example above, if the stock price goes to $65, the likelihood of assignment at $50 is low. Let's say that the options price falls to $0.50 from the original premium of $2. A trader could repurchase the option and close the original position. This eliminates the risk of assignment and leaves the trader with a $1.50 profit, or $150 because of the options contract multiplier. The trader could then write another put at a different strike and expiration if they choose to collect additional premium.

Even if the stock price doesn't increase, the time value of the option will decay as expiration gets closer. This generally causes a drop in the price, allowing a trader to buy the option back, lock in their profit, and move on to the next trade, if they so choose.

• While a cash-secured put is used primarily as an income-generating strategy, you should only consider writing a put on a stock you would be comfortable owning. 
• If the price of the underlying stock drops substantially prior to the expiration date of the cash-secured put, your losses could be significant. Losses would be limited to the strike price down to zero minus the premium you received on the sale of the put. 
• A significant increase in the price of the underlying stock will generally result in a profitable trade, but your profit will be limited to the premium you receive on the sale of the cash-secured put. You wouldn't lose money, but you'd lose an opportunity to potentially have a larger profit on a long position in the stock. 
• Keep in mind that short options can be assigned at any time up to expiration regardless of the ITM amount. An ITM option has a higher risk of being assigned early.