A cash-secured put is an options trading strategy that involves selling a put option while simultaneously setting aside enough cash to buy the underlying stock.
This is an effective strategy when an investor is bullish on a stock but wants to buy the stock at a discounted rate. This article will explain how to effectively use the cash-secured put to an investor’s advantage.
Let’s look at an example of this strategy in action.
Assume stock ABC is trading at $60. An investor is interested in the stock but does not want to pay $60. He decides to execute a cash-secured put strategy. The investor sells one put option that expires in a month with a strike price of $57. He collects a premium of $2 per share for selling the put option. At the same time, he sets aside $5,700 in cash, in the event that he is obligated to buy the shares at the strike price.
Ideally, the stock price falls below $57 at expiration. If this happens, the put option would be exercised and the seller would be obligated to buy the shares of stock at $57. This is not a bad thing as the seller wants to own the shares of stock. By using this strategy, he gets the shares of stock at $57 rather than $60. Plus, he gets the premium of $2 per share.
In another scenario, if the stock never falls below $57 at expiration, then the put option would expire worthless. This is not bad for the seller either as he walks away with the premium of $2 per share.
In either scenario, the option seller pockets the premium and will get the stock that he wants at a discounted rate.
A cash-secured put is a great strategy for a bullish investor to buy a stock at a discounted rate. However, if an investor wants to capitalize on immediate gains in the stock, then this strategy is not the route to take. The investor is counting on a short-term dip in the stock price (just to become the owner of the stock), followed by a long-term rise in the stock price once he is the owner.
That is a specific scenario that must happen in order for the cash-secured put to be most effective. The odds of this scenario not happening are relatively high and that’s what makes this strategy risky.
But if an investor does believe that a stock will have a slight dip in price followed by a long-term rise in price, then this is a great strategy to get that stock at a discounted rate.
After reading this article, investors should feel prepared to use this effective options trading strategy.
