Shorting Cash-Secured Puts
Traders may write puts to receive premiums or to potentially purchase a security for less than its current market price. A cash-secured put ensures they have enough money to purchase the security if the option is assigned.
When you sell short or write a cash-secured put, you must have enough money in your account to cover the potential purchase of the underlying security. You receive a premium for taking on the obligation because the option may be assigned, meaning you would be required to buy the underlying stock at the option strike price. This cash reserve must remain in your account until the option position is closed, expires, or the option is assigned.
How could you use a cash-secured put strategy?
Cash-secured puts are used to produce income (through the premium received) or to possibly purchase the underlying security at a price lower than the current market price.
Selling short a cash-secured put is considered a bullish strategy. If your objective is to profit solely from the premium received, you would likely have a bullish outlook for the length of the option's life. If your objective is to acquire the underlying security you would likely have a longer-term bullish view.
What happens if the option is in the money at expiration?
If the put option is 1 penny ($0.01) or more in the money (meaning the market price is lower than the strike price) any time before or at expiration, the option can be assigned and you would be obligated to buy the underlying security at the put option's strike price.
What happens if the option is out of the-money at expiration?
If the put option remains out of the money (meaning the market price is higher than the put strike price) until it expires, the option expires worthless and your obligation to buy the underlying security expires as well. You will retain the premium.
If the put is at the money at expiration, meaning in or out of the money but by a very small amount, you could still be assigned if the long option holder exercises their contract.
How to Calculate Max Profit, Break-Even and Max Loss
The maximum profit from a cash-secured put is the premium received, minus commissions and fees. The break-even point is the strike price less the option premium received, or the price at which you would start to incur a loss. The maximum loss assumes you purchase the underlying security at the strike price and the stock price falls to zero. The loss would be partially offset by the premium received.
Profit and Loss Graph
On the profit and loss graph the vertical axis represents the profit or loss potential. The horizontal axis represents the security's price from low to high (left to right). The point where the profit and loss line (yellow line) crosses the horizontal axis represents the break-even point.
This illustration is hypothetical and does not reflect actual investment results, transaction costs, or guarantee future results.
The following factors can influence an option's premium and should be considered when implementing an option strategy.
Volatility: Periods of higher volatility may cause option premiums to rise. Periods of lower volatility may cause option premiums to decline.
Time Decay: The value of an option declines to its intrinsic value as it approaches expiration. The rate of decline increases as the option gets closer to expiration. Time decay can benefit the seller of an option and be a detriment to the buyer.
Delta: Delta helps measure the amount that an option's price could change relative to a one-point move in the underlying security's price. Out-of-the-money options tend to capture less of a price move than in-the-money options.
Assignment: Assignment happens to the seller of the put when the owner of the put option exercises his right to sell the underlying security at the option's strike price. Assignment can happen at any time on or before the expiration date with an American style option, but is unlikely if the option is out-of-the-money. A European-style option can only be exercised/assigned at expiration.