Options: 3 things to know about cash-secured puts
Editorial staff, J.P. Morgan Wealth Management
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 below its current market price. This strategy has potential benefits as well as significant risks that you should consider.
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Here’s an overview of a cash-secured puts 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) on 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 would sell a cash-secured put involving shares you don’t 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 end 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 x $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, let’s say 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 if the put was exercised.
Why might cash-secured puts make sense?
You earn the income from the premium, even if you do not have to purchase the security.
You may secure a lower price to purchase a security
You might use this strategy if you want to purchase the security at a defined price below the current price.
What are the risks?
If the security value drops significantly below your strike price (even to $0), you are still obligated to purchase the security at your 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 no riskier than a covered call. As long as you are comfortable with the potential risk associated with the asset you'd be obligated to purchase and the terms of the contract, cash-secured puts may be considered by some investors as an option 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 gets exercised.
For example, if a cash-secured put is sold at a strike price of $50 and the writer receives a $2 premium then they would need to keep $4,800 in cash in their account ($50 - $2) × 100 shares.
The seller of a cash-secured put can close their position at any time before expiration by buying it back. The option would likely be more expensive to buy back if the price of the underlying stock is lower than when the writer sold the option. 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’s a strategy designed to make a profit on assets that you believe will increase in value.
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Editorial staff, J.P. Morgan Wealth Management
