Cash-secured put options: What to know and how to use them
Editorial staff, J.P. Morgan Wealth Management
- When you sell a cash-secured put, you earn a premium and are obligated to buy the security if the put is exercised by the buyer.
- You must have enough cash in your brokerage account to cover the potential purchase at the strike price.
- If the market price drops below your strike price, you may be required to buy the security at that price.
When you sell a cash-secured put, you earn a premium from selling a put (creating an obligation to buy the underlying security if the put option is exercised by the buyer). You must maintain the cash for this obligation. When the sale of the put is executed, you will earn premium on this cash immediately. At any point up to expiration, your obligation may require you to buy the security at the strike price, which could be below the current market price. This strategy has potential benefits as well as significant risks that you should consider.
Here’s an overview of a cash-secured put option strategy.
How do cash-secured puts work?
- You sell a put, which obligates you to buy shares of an asset, such as a stock or exchange-traded fund (ETF), at a specific price (the strike price) by a specific day (the exercise date). The money you receive for selling that put is called the premium, which you receive immediately upon execution of the put. Typically, you sell a cash-secured put on shares you do not currently own.
- You must have enough cash available in your brokerage account if you are obligated to purchase the shares of the security. The full cash amount needed to buy the shares at the strike price is required to stay in your brokerage account through the duration of the put contract. This is why it is called a cash-secured put.
- If the market price of the security drops below your strike price before expiration, your put may be exercised by the buyer. At expiration, the market price of the security may be below your strike price. In both cases, you are obligated to buy the security at the strike price.
For example, stock ABC is trading at $100. You sell a cash-secured put contract with 100 shares at a $90 strike price that expires in three months. That put requires $9,000 of cash (100 shares × $90) to be maintained in your brokerage account; you earn a premium of $500 for selling the put.
At the end of three months, when the contract is at expiration, suppose ABC is trading above the strike price at $105. You have earned $500 of premium, and the put expires. However, if within three months, ABC is trading below the strike price at $80 and that put is exercised, you are obligated to buy ABC at $90 per share (even though the market price is currently $80). As the seller of the put, you would always keep the premium of $500 earned, regardless of whether the put was exercised.
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Why consider cash-secured puts?
You earn the income from the premium, even if you do not end up having to purchase the security.
Potential to secure at a lower price
You might use this strategy if you want to purchase the security at a defined price below the current market price.
What are the risks?
If the value of the security drops significantly below your strike price (even to $0), you are still obligated to purchase the security at the strike price.
Frequently asked questions about cash-secured puts
A cash-secured put is an options strategy in which you sell (or “write”) a put option on an asset – such as a stock or exchange-traded fund (ETF) – while also setting aside the capital to buy the stock if you are assigned. You are obligating yourself to buy an asset that you already want to purchase, but you can make money off of it because you are being paid a premium.
Cash-secured puts are generally considered comparable in risk to covered calls. If you are comfortable owning the underlying asset at the strike price (and with the contract’s terms), some investors view cash-secured puts as one way to generate income.
A put is an options contract that offers the buyer the right but not the obligation to sell shares (usually standardized at 100 shares per contract) at a specific strike price by a defined date on which that option contract expires (expiration date). The seller of this put (also known as the writer) is contractually obligated to buy that asset at that strike price if the buyer exercises their right to sell it, so the seller must have enough cash in their account to buy the stock at the strike price if the put is exercised.
For example, if a cash-secured put is sold at a strike price of $50 and the writer receives a $2 premium, they would need to keep $5,000 in cash in their account ($50 × 100 shares). The $2 premium is received separately.
The seller of a cash-secured put can close their position at any time before expiration by buying back the put option. The option would likely be more expensive to buy back if the price of the underlying stock falls below the strike price. Conversely, it would likely be less expensive if the underlying stock is higher than when the writer sold the option.
A cash-secured put is considered bullish. This is because it is a strategy designed to make a profit if the asset’s price remains above the strike price or increases in value.
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Editorial staff, J.P. Morgan Wealth Management
