Cash secured put

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What Is Cash Secured Put?

A cash secured put is an options strategy within the broader category of options strategies where an investor writes (sells) a put option and simultaneously sets aside enough cash to purchase the underlying stock if they are "assigned." This strategy reflects a bullish or neutral outlook on a stock, as the investor anticipates the stock price will remain above the strike price by the expiration date. In return for selling the put option, the investor receives a cash payment upfront, known as the premium. The primary motivation for entering a cash secured put is to generate income from the premium or to acquire shares of a company at a desired lower price.

History and Origin

The concept of options, including put options, has roots dating back centuries, with early forms existing in various markets. However, modern, standardized options contract trading began with the establishment of the Chicago Board Options Exchange (Cboe) in 1973. Cboe was the first exchange to list standardized, exchange-traded stock options, revolutionizing how these derivatives were traded.⁹ Initially, Cboe only offered call options, but it expanded its product offerings to include put options in 1977.⁸ This standardization and centralized clearing through entities like the Options Clearing Corporation (OCC) made strategies like the cash secured put more accessible and transparent for investors, enabling them to reliably manage risk and generate income.⁶, ⁷

Key Takeaways

• A cash secured put involves selling a put option and holding sufficient cash to buy the underlying shares if the option is exercised.
• The strategy generates income from the premium received when selling the put.
• It is used by investors who are bullish or neutral on a stock and are willing to own it at the strike price.
• The maximum profit is limited to the premium received, while the maximum loss occurs if the stock price drops to zero.

Formula and Calculation

The primary "formula" associated with a cash secured put relates to the maximum profit, which is simply the premium received. The premium itself is determined by various factors including the stock's price, strike price, time until expiration, volatility, and interest rates.

The premium (P) received for selling the put option can be conceptualized as:

The breakeven point for a cash secured put, where the investor neither profits nor loses money (excluding commissions), is calculated as:

For example, if an investor sells a put option with a $50 strike price and receives a $2.00 premium, their breakeven point is $48.00.

Interpreting the Cash Secured Put

Interpreting a cash secured put centers on understanding the investor's outlook and potential outcomes. An investor implementing this strategy expects the underlying stock to either trade flat, rise, or fall only slightly, remaining above the chosen strike price. If the stock price stays above the strike price until expiration, the put option expires worthless, and the investor keeps the entire premium as profit, without needing to purchase the shares. This outcome reflects a successful income generation strategy.

Conversely, if the stock price falls below the strike price by expiration, the put option is "in the money" and the investor will likely face assignment.⁵ This means they are obligated to purchase 100 shares of the underlying equity for each options contract sold, at the strike price. In this scenario, the investor effectively buys the stock at a net cost of the strike price minus the premium received. This result is acceptable for investors who genuinely wish to acquire the stock at a discount to its current market price. The risk, however, is that the stock price could fall significantly below the net purchase price, leading to a loss.

Hypothetical Example

Consider an investor, Sarah, who is interested in acquiring shares of Tech Innovations Inc. (TI) but believes its current price of $105 is a bit high. She wants to buy it if it drops to $100 or lower.

1. Sell the Put: Sarah sells one cash secured put options contract on TI with a strike price of $100 and an expiration date one month away.
2. Receive Premium: For selling this contract, she receives a premium of $3.00 per share, or $300 for the 100-share contract.
3. Cash Secured: Sarah ensures she has $10,000 ($100 strike price x 100 shares) in her account, which is the cash required to purchase the shares if assigned.

Scenario 1: TI's price stays above $100.
If, at expiration, TI's stock price is $102, the put option expires worthless. Sarah keeps the $300 premium, and no shares are purchased.

Scenario 2: TI's price falls below $100.
If, at expiration, TI's stock price is $95, the put option is in the money. Sarah is assigned and obligated to buy 100 shares of TI at the $100 strike price. Her net cost for the shares is $97 per share ($100 strike - $3 premium), for a total of $9,700.

Practical Applications

Cash secured puts are a versatile tool in options trading and can be applied in several scenarios:

• Income Generation: One of the most common applications is to generate regular income. Investors who are neutral or mildly bullish on a stock can repeatedly sell cash secured puts, collecting premiums as long as the stock stays above the strike price. This can supplement returns from other investments.
• Averaging Down: Investors looking to acquire shares of a specific company at a lower price can use cash secured puts as a "limit order." If the stock falls to their desired purchase price (the strike price), they are assigned the shares, effectively buying them at a discount (strike price minus premium). This can be a strategic way to improve the average cost of a position in a long-term portfolio.
• Portfolio Management: For investors managing a large equity portfolio, cash secured puts can be part of a broader risk management strategy. By selling puts on stocks they wouldn't mind owning, they can capture some premium during periods of low volatility or when waiting for entry points. The general disclosure of options trading risks is a key regulatory concern, as highlighted by the Securities and Exchange Commission's (SEC) "Characteristics and Risks of Standardized Options" document, which outlines the purposes and risks of options transactions.⁴ Options market activity, including puts, is a significant component of overall market volume. For example, options activity often spikes during periods of market uncertainty, as investors use them for hedging or speculation.², ³

Limitations and Criticisms

While a cash secured put offers benefits, it also carries inherent limitations and risks:

• Limited Profit Potential: The maximum profit for a cash secured put is capped at the premium received. Unlike owning the stock outright, where gains are theoretically unlimited, the put seller does not participate in any significant upward movement of the stock price beyond the premium.
• Significant Downside Risk: If the underlying stock falls substantially below the strike price, the put seller is obligated to buy the shares at the strike price, which could be much higher than the current market price. The maximum loss can be substantial, occurring if the stock price drops to zero, in which case the loss is the strike price minus the premium. This contrasts with a naked put, which carries unlimited risk if not cash-secured.
• Opportunity Cost: If the stock price rises significantly, the capital held aside to secure the put could have been used for other investments, leading to an opportunity cost where the investor misses out on larger potential gains from simply owning the stock or other strategies.
• Assignment Risk: The possibility of assignment means the investor must be genuinely willing and financially able to purchase the underlying equity. Failure to do so could lead to forced liquidation of other assets or a margin account call. Studies from institutions like the Federal Reserve Bank of San Francisco have explored the informational role of options markets and their sensitivity to market conditions, highlighting the complexities and potential risks involved in these instruments.¹
• Volatility Impact: A sudden increase in implied volatility can increase the value of the sold put option, making it more expensive to buy back and potentially delaying the ability to close the position for a profit, even if the stock price remains favorable.

Cash Secured Put vs. Covered Call

A cash secured put and a covered call are both options strategies that involve writing an option and are used to generate income, but they differ fundamentally in their underlying asset and market outlook.

The cash secured put is fundamentally about potentially acquiring stock at a desired price while collecting a premium, whereas the covered call is about generating income from existing stock holdings, with the willingness to sell those shares at a specific price. Confusion often arises because both strategies involve selling an option and receiving a premium, but their underlying risk profiles and primary objectives are distinct.

FAQs

Is a cash secured put a bullish strategy?

Yes, a cash secured put is generally considered a bullish to neutral strategy. The investor profits if the underlying stock price remains above the strike price at expiration date, or if it falls but stays above the breakeven point.

What happens if the stock price goes below the strike price?

If the stock price falls below the strike price by the expiration date, the investor will likely be assigned. This means they are obligated to purchase 100 shares of the underlying stock at the strike price for each contract sold. The cash set aside is then used for this purchase.

Can I lose more than the premium received?

Yes, you can lose more than the premium received. While the premium is your maximum profit, your maximum loss occurs if the stock price drops to zero. In this scenario, your loss would be the strike price multiplied by 100 shares, minus the premium collected.