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- Cash-Secured Puts: A Powerful Strategy for Retail Investors to Consider
Cash-Secured Puts: A Powerful Strategy for Retail Investors to Consider
Step away from the high-risk plays—discover how cash-secured puts can bring balance and profitability to your portfolio.
If you’ve spent any substantial amount of time in the investing world, you’ve likely come across traders and investors who mention ‘options.’ Many investors don’t fully understand how options work or even what they are. Maybe you’ve read a news article that referenced derivatives or seen online communities like the wallstreetbets subreddit portraying options trading as a form of gambling. But chances are, you have not been exposed to the responsible uses of options—or even realize that such uses exist.
If you do not have a basic understanding of options and how they can be used strategically, you could miss out on potential profits, income, or risk-mitigation tactics that ‘appropriately-used options’ may provide. In my humble opinion, there is too much of a stigma around the use of options in the retail trading and investing community. This stigma is fortified by the ads you’ve likely seen echoing the same phrases “quit your 9-5 through trading options” or “make $10k/month by trading options” on social media. While it is possible (though very, very improbable) to achieve these outcomes through trading options, most options ‘traders’ end up losing money.
Emotional pitfalls, limited knowledge, and overleveraging are just a few reasons traders often stumble, but the root cause is often an addiction to "hopeium." Buzzwords and phrases like “unlimited profit potential” fuel poor decision-making in the arena of buying call options. For the retail investing community, it's time to strike a balance by exploring strategies that may not seem as glamorous. With a basic understanding of the different types of options, we can deploy one of the most basic and commonly used strategies, the cash-secured put.
Brief Overview: Put Options
We first need to understand the ‘put’ option before we get into ‘cash-secured puts.’ Put options, one of the two primary types of options contracts, grants the buyer the right—but not the obligation—to sell 100 shares (standard contract is 100 shares) of an underlying stock at a predetermined price (the strike price) before or on a specific expiration date.
The buyer of a put may purchase the contract for downside protection, which can be likened to an insurance policy on the underlying stock, or the put buyer can simply purchase to speculate on a decrease in the stock price (along with a multitude of other reasons not mentioned). The cost to the purchaser of the put option is the contract’s ‘premium,’ which is paid to the seller of the contract.
The seller (or writer) of a put option agrees to the obligation to buy the underlying stock at the strike price if the buyer decides to exercise the option, and thus receives the premium paid from the contract buyer. This means, when you sell a put option, you could be “assigned” to purchase 100 shares of the underlying from the buyer of the put at the strike price.
For more information, I have included some helpful links on the basics of options, specifically put options. You can also check your brokerage’s educational resources, since most platforms have a course or program dedicated to options.
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You may be asking yourself: What is a cash-secured put and why should I care about any of this?
Well, a cash-secured put is a simple options strategy (that’s an oxymoron) that allows you to sell a put option to generate income while positioning yourself to buy a stock you are bullish on at a lower price (This sounds complex, but stick with me; There is a simplified example below). By selling a put option, backed by cash reserved to purchase the stock if assigned, you earn a premium upfront, regardless of whether the stock price falls.
This strategy gives you control over your entry price, reduces your overall cost basis on the stock, and provides a way to earn consistent income from the premiums received. They offer built-in risk management by ensuring your cash is fully prepared to cover the cost of purchasing the stock, making it an excellent choice for conservative, long-term investors.
One of the most exciting aspects of cash-secured puts is how time decay (known as theta) works in your favor. All else equal, options lose value as they approach their expiration date. This means that every day the stock price stays above your strike price, the option you sold decreases in value, allowing you to potentially close the position early for a profit or simply let it expire worthless. Time is your ally whilst utilizing cash-secured puts.
Additionally, by using cash-secured puts correctly, we’re able to set up a ‘win-win’ situation for ourselves. Let me provide an example:
This is Guy.
Guy is bullish on XYZ stock in the long-term, but thinks it is slightly overvalued. It is currently Jan. 1, 2025 and the stock price sits at $25/share. Guy believes it to be a worthwhile ‘buy’ at $20/share and would happily pay that price for 100 shares of XYZ.
So, being the crafty investor he is (maybe he subscribed to our free newsletter), he decides to sell 1 put option with a strike price of $20/share and an expiration date of Jan. 31, 2025, on XYZ stock. Guy will receive the premium paid by the buyer (Gal) of the put, which in this case is $1 per share. Guy receives $100 (remember, options are for 100 contracts; $1 per share x 1 contract (100 shares) = $100). Guy is now potentially obligated to buy XYZ at $20 per share through the expiration date.
Guy sets aside $2000 to purchase XYZ at the strike price in case he is assigned ($20 strike price x 1 contract (100 shares) = $2,000; quick note: your brokerage account will likely require you to set aside $1900, which is the $2000 purchase amount – the $100 premium received from selling the contract, as collateral to ‘secure’ your position).
There are two outcomes that could happen to Guy at expiration on January 31st.
Outcome 1 - The Stock Stays Above $20/share by Expiration
If XYZ’s stock price remains above $20/share by Jan. 30, 2025, the put option will expire worthless. The buyer of the put (Gal) will not exercise the option, as it wouldn’t make sense to sell shares at $20 when they could sell them for more on the open market. Guy keeps the $100 premium he received as profit and moves on, potentially selling another cash-secured put if he’d like, and starting over again.
Outcome 2 - The Stock Drops Below $20/share by Expiration
If XYZ’s stock price falls below $20/share, the buyer of the put option (Gal) is likely to exercise the option. Guy will be ‘assigned’ and his ‘potential obligation to buy’ becomes an ‘obligation to buy.’ Guy will then be obligated to purchase 100 shares of XYZ at the strike price of $20/share. However, because he already received $1/share in premium, his effective purchase price is $19/share ($20/share strike price – $1/share premium received). If Guy still believes in the long-term value of XYZ and wants to own the stock at $20/share anyway, this outcome aligns with his original goal.
In either scenario, Guy benefits from utilizing the cash-secured put strategy. It’s a win-win: he either keeps the premium as income or acquires the stock he wants at an effective discount.
It is important to note, however, that if the stock moves substantially upward to $30/share, the put option will not be exercised. Guy will keep his $100 premium but may feel disappointed that he missed out on the significant gain in the share’s price.
Conversely, if the stock dips substantially to $10/share, Guy will be obligated to purchase 100 shares at an effective price of $19/share ($20 strike price - $1 premium received). While this isn’t the most ideal outcome, if he remains bullish on the stock, he could hold it for long-term growth, and may even enter into another cash-secured put with the goal of purchasing more shares at a discount.
It’s also worth mentioning that, like all things in life, there is more nuance surrounding cash-secured puts, such as the ability to roll the position to extend the time frame or adjust the strike price for better outcomes. Additionally, investors should consider factors such as taxes, as premiums are often taxed as short-term capital gains, and trading commissions, which, while minimal with many brokers, can still affect overall profitability. Other considerations include account requirements, margin implications, and potential assignment risks when employing this strategy.
How Do I Start?
Begin by identifying stocks you believe in for the long term and would be comfortable owning at a lower price. With that in mind, you can select a put option that matches your investment goals. You can get an idea of the premium offered on each contract by looking at your brokerage platform’s options chain.
It's crucial to thoroughly educate yourself before diving in and consider testing the strategy with a simulated 'paper money' account. Read up on educational materials about options trading to better understand the risks and rewards. For personalized guidance tailored to your financial goals, consider talking to a financial advisor who can help you determine whether cash-secured puts fit into your overall investment strategy.
All this to say, getting started with cash-secured puts is simpler than you might think and could enhance your portfolio substantially. For more general tips, strategies, and in-depth explanations, subscribe to our free weekly newsletter. We’ll provide you with regular insights and actionable advice to help you navigate the world of investing with confidence. Click below to join the community.