Cash Secured Put: Complete Guide to This Options Strategy - Copyright © 2017-2024<br>© Lekafi Pty Ltd 2017/2024

Cash-secured put is a profit-generating option strategy that includes selling a put option while having enough capital in place to buy the stock if it gets assigned to you. To simplify, you write an agreement promising to buy 100 shares of stock for a premium. This approach is an excellent way to earn income while committing to buy a stock you\’re interested in owning. To know more about option trading strategies, visit our page on How to Trade Options: How to Generate Consistent Income.

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Explaining Cash-Secured Put with an Example

At first glance, this strategy might appear puzzling, but it becomes much clearer with a practical example. Let\’s use Apple\’s stock (AAPL) for a hypothetical scenario.

Suppose AAPL is currently priced at $100 per share.

• You could sell a $80 strike cash-secured put that expires in a month and receive a premium of $100 ($1 per share).

• You\’d be obligated to set aside $8,000 in case yozu are required to purchase the shares.

There are two possible outcomes for this trade:

• If AAPL stays above $80 at the end of 30 days, you simply pocket your $100 as income.

• If AAPL dips below $80 at expiry, you are obliged to buy 100 AAPL shares at $80 each, but you still get to keep the $100.

The Worst-Case Scenario for Selling Cash-Secured Puts

When delving into options strategies, it\’s crucial to be aware of the maximum potential loss, or in other words, the worst-case scenario.

By understanding the risks associated with cash-secured puts, you can prepare for even the most adverse outcome – that is, being assigned 100 shares of the stock at the strike price.

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Option selling strategies often face criticism because, without adequate understanding of the notional value, it\’s easy to overallocate your account, leading to significant losses. However, by selling cash-secured puts, you are not using any margin at all! The only issue that may arise is if you don\’t have enough capital to cover the cost of assignment when selling options. Some brokers allow you to cover just 20% of the required capital initially when selling put options, which might falsely inflate your sense of security.

Once you become an experienced trader, a small amount of margin usage could be fine if you know how to effectively manage your risk. For beginners, it\’s a good idea to stick with cash-secured strategies to avoid the dreaded margin call in a worst-case scenario, like a massive market downturn.

Best Practices for Trading Cash-Secured Puts

Trade only in liquid stocks.
Ensure that the bid-ask spread is not wider than 10-20 cents.
The \’SPY\’ ETF has the most liquid options and generally has a narrow penny-wide spread.
Avoid selling low-priced contracts.
If you sell a put and only get a premium of $.05, the fees will eventually offset your profits.
Even though weekly options expire sooner, trading them more frequently will lead to higher fees.
It\’s often better to take profits early. Instead of letting options expire worthless, close them before expiration to secure your profits and earn more premium. It\’s better to surrender a small amount of premium instead of letting the option expire entirely.

Important Points to Remember Before Trading Cash-Secured Puts

Writing cash-secured puts is an excellent way to understand how options work without the risk of a margin call. This strategy allows you to sleep peacefully and learn how options move based on the stock market\’s fluctuations. Remember, options were designed to leverage your account efficiently without paying margin interest. Once you get comfortable trading cash-secured puts, you can consider using margin to enhance your returns.

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Frequently asked questions (faqs)

q: what is a cash-secured put?

a: a cash-secured put is an income option strategy that involves selling a put option and setting aside sufficient capital to buy the stock if it gets assigned to you.

q: what is the worst-case scenario when selling cash-secured puts?

a: the worst-case scenario is being assigned 100 shares of stock at the strike price if you do not have enough capital to cover the cost of the assignment.

q: when can i use margin in trading?

a: margin usage can be beneficial once you\’re a more experienced trader and understand how to manage your risk effectively.

q: what are some trading tips for cash-secured puts?

a: it\’s advisable to trade liquid stocks, ensure the bid-ask spread is narrow, not to sell cheap contracts, and to take profits early.

q: why should i consider writing cash-secured puts?

a: writing cash-secured puts is a good way to learn how options work without the risk of a margin call. it allows you to leverage your account efficiently without paying margin interest.

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