Cash Secured Put

Cash Secured Put

What is a cash secured put trade, and how do we trade it? A cash secured put is a trade that sells a put to open the trade (STO), which requires a trader to have enough capital to cover the exposure presented from that STO position. Why?

When a trader buys a put, they are buying the right to sell shares at that strike price, but when a trader STO a put, they are obligated to provide the stock if the put buyer exercises their rights and “Puts the Stock” onto the short seller.

This means the trader could be compelled to purchase 100 shares of stock at the strike price we STO. If the stock rises, we would only have the risk if someone exercises their rights as the buyer of an option, but – if the short put option is ITM at expiration, then we will automatically have the option exercised. We will end up with 100 shares per put lot sold.

Options buyers have rights – they have the right to exercise their options, but options sellers only have obligations – they are obligated to cover the position if the option does get exercised. So when a trader sells a put – they are “on the hook” to cover 100 shares of stock at the strike sold.

There are several ways we can “cover a put,” which includes buying a put at a different strike or at a different expiration, but we can also cover it with the cash in our account. Suppose I have a 100,000 account and want to STO a put on a stock trading for 25.00. I must ensure I have enough free capital to cover \$2,500.00 and expect my buying power to drop in the account.

Cash Secured Put Example

Suppose I decided to STO the 25 strike put – a ten lot order? I would reduce my free capital by 25,000 and have a short position of 10 puts at the 25.00 strike. Let’s say I collected 4.35$ for each put and opened the position for a net credit of 43.50$ (or 4,350.00$).

As time passes, these puts will decay from the Theta loss. And (hopefully) the price will stay above the 25.00$ position. This would help us see profit from the options decay. If we STO, we have to buy to close (BTC). We would want to buy these back cheaper than we sold them to open.

A typical tactic for premium traders is to target a 50% profit area. This means we would seek to exit the position after the trade has matured into half its opening price (4.35 / 2 = 2.175), so we could place an exit order (BTC) for anything lower than 2.17 per contract to hit that profit target.

 

Cash Secured Put Closing

We could also “layer out” an exit. Closing some options at 35% profit, some at 50% profit, and maybe even closing some at 75% profit. Some traders like to hold to expiration, taking additional risks for minimal rewards. Why?

Holding until expiration to keep 100% of the credit collected exposes us to the violent changes in options premiums seen in the last ten days of an options life. Also – statistically – the last 25% of the option’s value can take as long to achieve as the first 75% of that option’s profit did. Consider it another way. Suppose the put we sold for 1.00 to open had 45 days until expiry. After 15 days, the options price has dropped 60%. Great!

But – we still have another 30 days until expiration and will only collect another 0.40¢ if we wait. We could get out of this trade & find another trade that could see that initial decay speed without waiting so long. 

Alternate Profit Considerations

Of course – there are other things to be concerned about – the current quarter and when a new earnings season begins, the threat of a possible dividend, investor day events, pending lawsuits, or new products coming to market… it’s important to be flexible when thinking about where we would exit.

If the stock price has not traveled too far from our entry and the strike is still relatively close, a trader may consider taking a smaller profit target before an event like FOMC or earnings. It’s perhaps better to take the profit and eliminate the threat.

Practice in a Simulated Account

Since options, including a cash secured put, have so many moving parts, you’ll want to practice trading them in a simulated account. ThinkorSwim by TD Ameritrade is one of our favorites.

With a paper trading account, you can place hundreds of practice trades before using real money. As a result, you can work out the kinks and see what options trading entails.

Trading is emotional as well. As a result, practicing allows you to learn to control those emotions. However, we realize that it’s a whole different animal once you go live.

Losing money when practicing is much less risky than going full throttle out of the gate. It protects you, and you learn how to sell puts.

Defending the Position

A cash secured put has more flexibility for adjustments (for defending a trade) versus utilizing a put spread – simply because a spread has already defined the risk while an STO put (or a “naked put”) is just that – its risk has not been defined beyond the cost of the stock (which a trader would be obliged to buy if the put were exercised).

When we cash secure an STO, the trader can add a long put later to “cover the other side” and thus eliminate the “cash-secured” part of things. Why would we do that?

Suppose we took that short put example above & sold ten puts ATM – and the stock fell below 25.00 and could fall into very strong support at 20.00. One thing we could consider doing is buying puts at the 20.00$ strike. Why? A long put gives us the right to “put the stock” on someone at the strike who bought it. We may have to buy the stock at 25.00 a share (if exercised), but we would now have the right to sell the stock at 20.00\$ if needed because we could exercise our right as a put buyer.

This is now considered a put credit spread – and we spent the credit we collected when we started the position to purchase these long puts. There could still be a threat of loss – but it now has been greatly reduced, and it has been “capped,” and the trade is no longer “cash-secured” but instead, is secured by the long put. 

What to Look for When You Sell a Put

  • You’re taking the bullish bias when you sell puts. As a result, you need to know when a stock will reverse from the downside.
  • How can you find that out? By looking at candlesticks and patterns along with support and resistance. If you want to sell, look to sell when it can’t break support. 
  • Once it returns to resistance, you’re in the green while someone else is in the red. That might sound harsh. However, that’s the nature of stock trading.
  • The stock market is a battle of buyers and sellers. It’s what moves the market. Without that battle, there’s be no price action. Without price action, no one would make any money.
  • Candlesticks are the foundation of trading. Without candlesticks, technical analysis means nothing. By themselves, candlesticks tell a story. However, group them, and you’ve got patterns.
  • These patterns, coupled with technical analysis and support and resistance, will give you a pretty clear picture of the type of trade you should be making.
  • Remember that this trade is often used to get the stock – so we would not want to employ this tactic on a company we do not want to own.
  • Remember that even the best traders fail 30-40% of the time. You may not hit it out of the park every time, but you’ll do well if you trade the setups.

Cash Secured Put Chart

Below is a picture of $AAPL stock after earnings. Suppose we were interested in trading AAPL stock; we wanted to sell puts on this. We would want to ensure we have the capital to trade. We would want an account that could easily cover the share cost. For our example, we will consider selling the 180 strike puts.

We’d need an account that could cover 18,000\$ in stock. Most trading books will say not to trade any one position with more than 15% of our total account – an account with more than 120,000$ available capital.

Cash Secured Put

AAPL’s earnings were good, and the stock popped up. The concern is whether AAPL will fall back down and close that gap or if the earnings gap will hold. Rather than just buying the stock with this earnings gap up – we could sell a put at 180 and wait.

The picture shows that the 180 put has 43 days to expiration and is trading at 2.60 with a tight spread. It has a 31 Delta, so a roughly 30% chance of closing ITM at expiration.

We could consider closing this at 50% profit for an exit strategy in profit. If we filled on the mid & STO the trade for 2.62, we could try to close the trade (buy to close BTC) at 1.31 or less.

We could consider buying a put at 185 for an exit strategy in defense. This would make this a put debit spread) or buying the 175 put would make this a put credit spread.

If we think AAPL will tank and not recover soon, we could abandon owning shares and have a bullish, neutral cash-secured put. So converting out STO cash secured put into a put debit spread would limit our loss to the difference between the strikes.

Example

We don’t know the option price at any point in the future. Imagine we were to try adding the 185 put (BTO) after the put has increased by 50%. Right now, the 185 puts are trading for 4.55, so let’s say it’s trading at 6.82\$.

We had collected 2.60 in credit to open, reducing the total “cost” of the long call (6.82 – 2.30 = 4.52). That is now our cost for the put. This isn’t ideal, but it WOULD limit the total risk to 5.00$ (the width of the 180 / 185 put debit spread).

We could decide that the fade in AAPL is just a momentary pullback & “reduce our risk” by converting the cash secured put into a put CREDIT spread – by buying the 175 put. Again, this would be defense. This means we had seen the stock do something that made us believe we should defend the trade. Maybe AAPL had broken 180 and fell towards the gap close. The 175 puts would be more costly than they are in the picture. So, let’s assume they increased by 50%.

The 175 puts are trading at $1.49 in the picture. Let’s say we have to buy them for 2.23 each. We had STO the 180 puts for $2.30. Now we’re spending that to buy a put for protection at 2.23\$, leaving us 0.07¢ credit and changing out the cash secured put for a put credit spread. This is also not ideal. Since that means we have a 5.00 wide put credit spread & our max loss is again the width of the spread (5.00$).

AAPL Puts

Final Thoughts: Cash Secured Put

A “cash secured put” is an options position opened by selling a put to start the trade – exposing the trader to the potential risk of assignment of 100 shares at the strike price sold. The entire trade is “secured” by funds in the trader’s account, and those funds will be tied up until the put is BTC or until some other option is added to the trade to secure the position.

You’re taking a bullish bias on the trade when you sell a put. As a result, you’re doing the opposite of what you’re used to when buying calls and puts because you are short instead of long. That may take some time to get used to. Hence, you must practice in a paper trading account before even dreaming about doing it live.

If you need more help, take our options trading course.

Frequently Asked Questions

A cash secured put is bullish. If the price rises or stays the same, the put price loses value. 

You can loose the entirety of the trade if it goes to $0. 

You want to roll a cash secured put before it gets too deep in the money. 

The seller of the cash secured put can close it out anytime by buying it back before expiration. 

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