A cash-secured put is an options strategy where an investor sells (writes) a put option and simultaneously sets aside enough cash to purchase the underlying stock at the strike price, if assigned. This means you have the obligation to buy 100 shares of the underlying stock per put contract sold (as most options contracts control 100 shares).

Why Sell a Cash-Secured Put?

• Potential to Acquire a Stock at a Discount: Your ultimate goal is to have the put option expire worthless so you can keep the premium. But, if the stock price falls below the strike price and the option is assigned, you’ll acquire the stock at a lower price than the current market price (strike price minus the premium received).
• Income Generation: You receive a premium upfront for selling the put option, generating income regardless of whether the stock price drops and you are assigned.

Mechanics of a Cash-Secured Put

1. Identify a Stock: Choose a stock you wouldn’t mind owning long-term and are comfortable buying at a lower entry point.
2. Determine a Strike Price: Select a strike price at which you’d be happy to purchase the stock. This may be slightly below the current market price.
3. Sell the Put: Sell (write) one put option contract for every 100 shares you’re willing to buy at the strike price.
4. Secure Cash: Ensure you have enough cash in your account to buy the stock at the strike price in case you are assigned.
5. Collect the Premium: Receive the premium associated with selling the put option.

Possible Outcomes

• Price Stays Above Strike (Optimal): The stock price remains above the strike price, and the option expires worthless. You keep the premium and do not buy the stock.
• Price Falls Below Strike (Assigned): If the stock price falls below the strike price, you might be assigned the option, obligating you to buy the underlying stock at the strike price. You collect the premium and acquire the shares at a discounted price.

Example of a Cash-Secured Put

• Stock XYZ is trading at $50 per share.
• You sell a cash-secured put with a strike price of $45 and an expiration date one month away.
• You receive a premium of $2 per share ($200 for the contract).
• If the price of XYZ stays above $45 by expiration, the option expires worthless, and you keep the $200 premium.
• If the price drops to $40, you will likely be assigned and have to buy 100 shares of XYZ at $45. However, your effective cost per share is $43 ($45 – $2 premium received).

Breakeven Price Calculation

In a cash-secured put strategy, the breakeven price represents the stock price at which your total gain or loss becomes zero, considering both the premium received and the potential cost of buying the stock at the strike price if assigned.

Here’s the formula for calculating the breakeven price:

Breakeven Price = Strike Price – Premium Received

Example:

• You sell a cash-secured put on Stock XYZ with a strike price of $45 and receive a premium of $2 per share.

Calculate the breakeven price:

Breakeven Price = $45 (Strike Price) – $2 (Premium Received)

Breakeven Price = $43

Therefore, if the stock price of XYZ is $43 or higher by expiration, you will break even because the premium received will offset the cost of buying the stock at the strike price. If the price is below $43, you will incur a loss due to the stock price decline outweighing the premium.

Risks to Consider

• Stock Price Drop: If the stock price falls significantly below the strike price, you may incur a loss even after factoring in the premium received.
• Capital Commitment: You must have sufficient cash on hand to buy the stock if assigned.
• Limited Upside Potential: While you can profit by acquiring the stock at a discount if assigned, you miss out on potential gains if the stock price rises significantly above the strike price.

Remember, the breakeven price only considers the financial aspect of the strategy and doesn’t factor in any potential dividends received or opportunity costs associated with missing out on potential gains if the stock price rises significantly above the strike price.

Best Suited For:

Cash-secured puts are a moderately bullish strategy best suited for investors interested in buying a stock at a discount and are willing to accept the obligation to buy if the stock price falls.