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Cash-Secured Puts

NOTE: This graph shows profit and loss of long stock and the short put.

The Setup

  • Sell a put, strike price A
  • Keep enough cash on hand to buy the stock if the put is assigned
  • Generally, the stock price will be above strike A

Who Should Run It

Rookies and higher

NOTE: Cash-secured puts can be executed by investors at any level. The Rookie’s Corner suggests other plays more suited to beginning options traders.

When to Run It

You’re slightly bearish short-term, bullish long-term.

The Sweet Spot

You want the stock price to be just below strike A at expiration. Remember, the goal here is to wind up owning the stock.



About the Security

Options are contracts which control underlying assets, oftentimes stock. It is possible to buy (own or long) or sell (“write” or short) an option to initiate a position. Options are traded through a broker, like TradeKing, who charges a commission when buying or selling option contracts.

Options: The Basics is a great place to start when learning about options. Before trading options carefully consider your objectives, the risks, transaction costs and fees.

The Strategy

Selling the put obligates you to buy stock at strike price A if the option is assigned.

In this instance, you’re selling the put with the intention of buying the stock after the put is assigned. When running this strategy, you may wish to consider selling the put slightly out-of-the-money. If you do so, you’re hoping that the stock will make a bearish move, dip below the strike price, and stay there. That way the put will be assigned and you’ll end up owning the stock. Naturally, you’ll want the stock to rise in the long-term.

The premium received for the put you sell will lower the cost basis on the stock you want to buy. If the stock doesn’t make a bearish move by expiration, you still keep the premium for selling the put. That’s sort of nice, because it’s one of the few instances when you can profit by being wrong about the direction of the stock.

Maximum Potential Profit

Potential profit is limited to the premium received from selling the put. (If the puts are assigned, potential profit is changed to a “long stock” position.)

Maximum Potential Loss

Potential loss is substantial, but limited to the strike price if the stock goes to zero. (If the puts are assigned, potential loss is changed to a “long stock” position.)

Break-even at Expiration

Strike A minus the premium received for the put.

TradeKing Margin Requirements

You must have enough cash to cover the cost of purchasing the stock at the strike price.

NOTE: The premium received from establishing the short put may be applied to the initial margin requirement.

As Time Goes By

For this strategy, time decay is your friend. You want the price of the option you sold to approach zero. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back.

Implied Volatility

After the strategy is established, you want implied volatility to decrease. That will decrease the price of the option you sold, so if you choose to close your position prior to expiration it will be less expensive to do so.

Options Guy's Tip

  • Don’t go overboard with the leverage you can get when selling puts. A general rule of thumb is this: If you’re used to buying 100 shares of stock per trade, sell one put contract (1 contract = 100 shares). If you’re comfortable buying 200 shares, sell two put contracts, and so on.


Tools

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