So, you like a stock but would rather buy it at a lower price? There is a way to make that happen.
Cash-secured puts offer an opportunity to generate income and buy a stock at a lower price. Keep reading to know what they are, how they work, and their associated risks.
How Do Cash-Secured Puts Work?
As an options trader, you’ve probably read about numerous buying strategies. Fortunately, there are also effective selling strategies that often aim to generate periodic income.
The cash secured put strategy is one example. Here’s how it works:
Sell the put: You sell a put option, giving the buyer the right to sell you their shares at a specific price (the strike price) by a certain date.
Put aside cash: Set aside cash to cover the cost of the shares that you may be assigned if the put buyer exercises the option. Why? Because, as the seller, you’re obligated to assume ownership of the underlying asset at the options strike price.
Receiving the premium: You receive a payment, called a premium, for selling the option.
What are the possible outcomes?
Your stocks face market conditions. If the price remains above the strike price near or at the expiration date, the put option is worthless, and you keep the premium as pure profit.
But if the underlying stock price declines, there’s a great chance you’ll be assigned the put. This means you need to purchase the underlying stocks with the money you set aside earlier.
At this point, you can buy the stocks at a lower price since you acquired a premium from the buyer earlier. This is why some investors think of the cash-secured put as a way to get into a stock at a lower price and get paid a little along the way.
Pros of Cash Secured Puts
The benefits of cash-secured puts include:
- Opportunity to secure income. As a seller, you collect a premium upfront. This cash is yours to keep regardless of whether the option is ultimately exercised or expires worthless.
- Discounted stock acquisition. The strategy can be used to acquire desirable stocks at a low price. The premium you acquired earlier effectively lowers your net purchase price.
- Time works in your favor. With time and economic changes, stock options typically fluctuate in value, which is beneficial to your position.
Check out SoFi’s options trading platform to implement cash-secured puts.
Risks of Implementing a Cash Secured Put Strategy
While cash-secured puts offer numerous advantages, there are some potential risks and trade-offs you should be aware of. For instance, if the stock price decreases dramatically, it may even drop to $0. In such situations, you would still be obligated to purchase the security at the higher strike price. Worst case? You would be holding a priceless security.
Another trade-off is the large amount of cash tied up. As mentioned earlier, you must set aside a substantial amount of cash (equal to the strike price multiplied by 100 shares per contract) to cover the potential purchase obligation.
Despite the risks, a cash-secured put is an excellent opportunity for investors to earn income.
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