It’s no secret that options can be an extremely versatile and useful tool when used by themselves or in conjunction with an existing stock position. The cash secured put writing strategy uses put options as a vehicle for potentially generating income from stocks you wouldn’t mind owning at a certain price. It may make better use of investment capital while potentially allowing you a way to buy stocks you already want at a lower price.
Here’s basically how it works:
- Pick a stock you wouldn’t mind owning at a lower price
- Look at put options for that stock that are at the price you would consider purchasing the shares
- Sell one put for every 100 shares worth of stock you would buy at that price
- Rinse and repeat
The idea behind the strategy is to generate income from the short puts expiring worthless. If the stock falls, your puts may go in the money, so you must be prepared to be on long the shares from your strike price. You must have enough cash in your account to cover the purchase of shares if your puts are exercised.
While selling cash-secured puts can potentially generate income, that income is limited to the amount of premium collected and you could possibly miss out on additional upside in the stock. For example, Investor Bill likes stock ABC which is currently trading at $24 per share. Bob would not mind owning the stock at $22 per share. Rather than buying shares at $24, Bill decides to sell two front month $22 put options for a combined premium of $1.00.
If the stock is at or above $22 at expiration, Investor Bill keeps the $1.00 premium collected. If the stock falls below $22 at expiration, Bill will be assigned a long position in ABC at $22 per share.
In this case, because he sold two puts, Investor Bill must have enough cash in his account to buy 200 shares of ABC at $22.