Cash Secured Put Strategy For Beginners
In this guide, we explore the Cash-Secured Put, a powerful and conservative strategy for any investor who has cash sitting in their retirement account. It’s an ideal way to put that cash to work, generating income while you patiently wait to buy high-quality stocks at a price you choose.
In a way you are getting paid to wait to buy stocks!
Think of this strategy as being paid to place a limit order on a stock. With a normal limit order, your money sits idle, waiting for the stock to hit your target price. With a cash-secured put, you collect a premium—an upfront cash payment—for simply agreeing to buy a stock you already want at a price you are already comfortable with.
Who Is This Strategy For?
The Cash-Secured Put is a perfect fit for an investor who:
- Has cash in their IRA they are looking to deploy into the market.
- Has identified a high-quality stock they want to own for the long term, but feel its current price is a little too high.
- Is disciplined and patient, willing to wait for their target price to be met.
- Would be happy with one of two positive outcomes: earning income or acquiring a great stock at a discount.
This strategy is not for someone who is unsure about the stock they are targeting or who might need their cash for other purposes in the near future.
How to sell cash secured puts for income:
Step 1: Choosing the Right Stock (This is the Most Important Step)
Choosing Stocks for Cash Secured Puts
The absolute golden rule of this strategy is to only sell puts on companies you truly want to own for the long haul. Since you might end up buying the stock, your decision should be based on the quality of the underlying company, not the size of the option premium.
What Makes a Good Stock for Selling Puts?
- A High-Quality Business: Focus on established, financially sound companies with strong fundamentals that you would be happy to have as a core holding in your retirement portfolio.
- A Price You’re Willing to Pay: You must have a clear idea of the price at which you believe the stock is a good value. This target price will become your strike price.
- High Liquidity: Just like with covered calls, the stock and its options need to have high daily trading volume and open interest to ensure you get fair pricing and can manage your position easily.
Step 2: Selling Your First Cash-Secured Put – A Walk-Through
Let’s walk through an example. Imagine you want to own “Blue Chip Inc.” (BCI). The stock is currently trading at $102 per share, but you believe it would be a great buy at $100. You have at least $10,000 of cash in your IRA that you can use.
- Log in and Find the Option Chain: Go to your brokerage account, look up BCI, and navigate to the option chain.
- Choose an Expiration Date: Select an expiration date that is 30 to 45 days away to take advantage of the sweet spot of time decay. Another popular strategy is to sell weekly expirations (if that particular stock offers weekly’s). This will take a little more managing but it can possibly offer a higher return on your investment, as collecting 4 weekly premiums usually is higher than collecting one monthly premium.
- Choose a Strike Price: You will select the $100 strike price, as this is the price at which you are happy to buy the stock. This is an “out-of-the-money” (OTM) Put because it’s below the current $102 stock price.
- Check the Premium: You look at the premium for the $100 put option and see it’s trading for $1.50.
- Place the Order and Secure the Cash: You will place a “Sell to Open” order for 1 contract of the BCI $100 strike price put option.
- Immediately, $150 ($1.50 premium x 100 shares) is credited to your account. This is your income for the trade.
- At the same time, your broker will “secure” (it won’t be available to open any other trades, temporarily) $10,000 of your cash ($100 strike price x 100 shares). This cash is held as collateral to ensure you can fulfill your obligation to buy the stock if needed.
Step 3: Understanding the Possible Outcomes at Expiration
Fast forward 30 days (or a week) to the expiration date. There are two potential outcomes, and both are beneficial to you as the put seller.
Outcome #1: The Income Scenario (Stock Stays Above the Strike)
The stock price of BCI is above the $100 strike price (e.g., it’s at $101 or higher).
- The put option expires worthless.
- Your obligation to buy the stock disappears.
- Result: You keep the full $150 premium as pure profit, and the $10,000 cash that was secured is now released. You successfully generated a return on your cash. You can now repeat the process if you still want to buy the stock.
Outcome #2: The Stock Acquisition Scenario (Stock Falls Below the Strike)
The stock price of BCI is below the $100 strike price (e.g., it’s at $98).
- The put option is “in-the-money” and will be assigned. Your broker will automatically use your secured $10,000 to buy 100 shares of BCI for the agreed-upon price of $100 per share.
- Result: You now own 100 shares of the company you wanted. More importantly, your effective cost basis is lower than the price you agreed to pay.
- Cost Basis Calculation: Strike Price – Premium Received = $100 – $1.50 = $98.50 per share.
- This is a successful outcome. You acquired a great company at an effective price that was even better than your original target. Now that you own the shares, you can begin selling covered calls against them, if you want to, and collect dividends (if this company pays dividends), or wait until it increases in value and sell. Caution: while your holding the stock it may also drop in value, however, if you have chosen your stock wisely that is a longshot…but it happens.
Step 4: Managing Your Position Before Expiration
You don’t have to wait until expiration. You have the flexibility to manage your position at any time.
- Closing the Position Early: If after a couple of weeks (or days), the stock price has risen and the put option you sold for $1.50 has decayed to just $0.20, you can choose to “Buy to Close” the position. This would cost you $20, locking in a net profit of $130 ($150 received – $20 paid) and releasing your secured cash immediately.
- “Rolling” the Position: If the stock is hovering near your strike price and you’d rather continue generating income than buy the stock just yet, you can “roll” the position. This involves buying back your current put and selling a new one with a later expiration date and often a lower strike price, usually for another net credit.
The Main Risk You Must Understand
- Stock Price Falls Dramatically: This is the primary risk of the strategy. If BCI’s stock price were to plummet to $80 due to bad news, you are still obligated to buy the shares at the $100 strike price. You would immediately have an unrealized loss of $20 per share (though cushioned slightly by the $1.50 premium you received). This risk highlights why the golden rule is so important: you must only sell puts on high-quality companies you are comfortable owning, even if the price drops after you buy them.
Congratulations! You now have a complete framework for using the Cash-Secured Put strategy to either generate income from your cash or acquire great companies at a discount.