Cash-secured Puts

Many investors shy away from selling puts because the strategy is viewed as too risky. Yet, the potential risks and rewards are very similar to owning stock. This is especially true when the investor has the cash in the account to cover the purchase of shares if assigned on contract.

Put options typically increase in value when the price of the underlying stock moves lower and decrease in value when the price of the underlying moves higher. Therefore, a put owner wants the stock price to move lower and a put seller, or "writer," wants the price to move higher. Meanwhile, the cash-secured put strategy is merely a form of put writing, but the investor has enough funds in the account to cover the cost of buying shares if assigned on the puts.

Remember, selling a put obligates the investor to buy or have the stock put to them at the strike price of the option through the expiration date. One hundred shares of stock are bought for every put that is assigned.

The put writer collects a premium for selling the option and, if shares stay above the strike price of the contract through the expiration, the option expires worthless and the investor keeps the premium, which is typically the main motivation with the put write strategy.

Figure 1: Short Put Risk Profile

Figure 1 shows a typical risk-reward graph for a short put. If the stock moves lower, the puts increase in value and the position loses because the investor is short the puts. The risk is defined to the stock going to zero. The gains are limited to the premium received. The breakeven at expiration is equal to the strike price minus the premium collected.

Put sellers often plan to close their positions before expiration. If the stock has moved higher or sufficient time has passed, it will probably be possible to close the position through an offsetting purchase.

On the other hand, if the stock falters, the investor may choose to either close the position for a loss or, if the puts are in the money, wait for assignment at or near expiration. At that point, 100 shares are bought at the strike price for every put option that was sold.

Conclusion

If expiration is approaching, make sure you are prepared. This is especially true of American style options that can be exercised before expiration because, once assignment happens, it is too late to close the position. All in-the-money (ITM) options will be exercised/assigned at expiration. If that is not the desired outcome, close the position or contact your brokerage firm to discuss the best course of action.