Playbook: Asset-Based: The Secured Cash Put

Cash-Secured Put

When running this strategy, you may wish to consider selling the put slightly out of the money. If you do so, you’re hoping that the stock will make a bearish move, dip below the strike price, and stay there. That way, the put will be assigned, and you’ll end up owning the stock. Naturally, you’ll want the stock to rise in the long term.

The premium received for the put you sell will lower the cost basis on the stock you want to buy. If the stock doesn’t make a bearish move by expiration, you still keep the premium for selling the put. And you can keep on preparing this every month.

The cash-secured short put is a variation of the short put. In the long-term is also bullish, but it needs a bearish move to capture the stocks at a cheaper price, which is the end-goals of the cash-secure put. It is a simple, short-term income strategy (generating income on a regular basis). Such strategies are typically short-term. Option premium is sold on a monthly basis.

A put is an option to sell. The seller has the obligation to take the other side (sell the put). The buyer of the put option has a right to take delivery (of the put).

So, selling/shorting a put means that the seller has the obligation to sell the obligation to sell the put. The buyer of the put has a right to take delivery of the obligation (the put). In other words, when you sell a put, you have sold someone the right to sell. You may need some time to think this over :).

The position benefits from IV/IVR contraction and/or underlying price decreases below the strike.

Considerations

General

The reason for selecting this option strategy is that you want to buy the stock at a discount, that is below the current price or to earn a reasonable return on the cash deposit without taking risk greater than owning stock.

So you want it first to be bearish, However, your long-term expectation is bullish. You expect the underlying to rise and be eventually bullish.

If that happens, it is also nice, since the ‘In The Money’ put (ITM: stock > short put strike price) enables you to pick up short-term premium. You can repeat this every month until the stock goes down enough for you to get assigned.

Initially, selling a put results in less exposure to the stock than buying/long 100 shares outright.

These are the considerations for entering a short put:

• You want the stock price to be just below the strike at expiration. The goal here is to wind up owning the stock.
• The long-term expectation that underlying (stock, ETF, index, future) will rise or go sidewards: the outlook is clearly bullish, looking for options to increase in value over time.
• Selling premium is expensive.
• Collecting premium over time as ‘income.’
• Instead of buying stock/shares outright, but seeking discounted ‘assigned’ long stock.
• Hedging against short/bearish positions.
• Adding positive theta to the portfolio.
• Adding a bullish leg to existing (e.g. long) strategies to limit risk.
• The underlying has just experienced a pullback/decline.
• Implied Volatility (IV)/IVR (IV Rank) is high (>30).
• The maximum reward is limited to the premium.
• Risk is unlimited to zero.
• When you sell a (put or call) option, time (value) decay helps, so typically, expiration dates should be reasonably not too far away (ideally around 45 DTE, so in the last month before the option’s expiration); so the period of trade is one month or less.

Description

Set-Up

1. Sell a put, slightly OTM/ATM (50Δ) close to strike price (in case of a naked short put this would be 30Δ )
2. Keep enough cash on hand to buy the stock if the put is assigned
3. Generally, the stock price will be above the strike.

Please note that 50Δ is equivalent to 50 shares of exposure.

Related Options Strategies

The cash-secured put is based on the short put.

The short put is equivalent to having 100 shares long in underlying plus a short call (called a’ synthetic short put‘).

The Greeks

GREEK

+/-

Notes

Profile

Delta (direction speed)

+

Positive and falls to zero after the position reaches its maximum profit potential after the stock has risen above the strike price.

Gamma (acceleration)

–

Always negative with naked put (because it is sold/shorted), and peaks inversely when Delta is at its fastest (steepest: around strike price /ATM)

Theta (time decay)

+

Positive since time decay works helps the short put option.

Vega (volatility)

–

Volatility is hurtful to the position since higher volatility = higher option value

Rho (interest)

+

Positive, higher interest rates increase the value of calls and help the position

Entry Rules

Profitable short puts (or getting cheaper stock through assignment) require correctly selecting bullish underlyings AND good timing.

Criteria

• Acknowledge whether market sentiment allows trade.
• Check whether trade fits in portfolio allocation rules.
• Ensure stock meets all of your selection criteria (volume, open interest, ask-bid range, etc.).
• IV/IVR above 30%.
• Ensure the trend is bearish but most likely will become upward/bullish.
• Ensure at least three of the technical momentum indicators are positive.
• Identify the clear areas of support and resistance.
• Make sure there are no major events (dividends, earnings) within 30 days of the expiry date.
• Profitability of Profit at selected strike: around 50% or wait until assignment.
• Backtest (since 2006 and last 200 trades): at least $1.00 (average and mean) profit/day.

Technical Indicators Used

1. Trend = bearish short-term, bullish long term
2. Support & Resistance = the underlying has just experienced a pullback/decline to a clear support level
3. RSI = overbought
4. Bollinger Bands in combination with Keltner Squeeze: at the bottom and outside Keltner bands
5. ADX/DMI: increasing up and above 20
6. ATR high

P/L and Risk Profile

Net Position

Net credit, because you get a premium when selling the put option.

Theoretical Profit

If the puts are assigned, potential profit is changed to a “long stock” position.

As long as the stock doesn’t go down for it to be assigned, time decay works positively with your sold put option. It will be eroding the value of your put every day, so all other things being equal, the put you sold will be declining in price every day, allowing you to buy it back for less than you bought it for unless the underlying stock has fallen, of course.

The reward is the credit, realized when the underlying price => put strike.

If the underlying price increases above the short put: expires worthless, and the seller can keep the premium. The seller can then set up another cash-secured put by selling again a slight OTM/ATM put and repeat his until he/she gets assigned. Of course, if the stock remains bearish, the seller should stop. Or the cash can be held in reserve be invested elsewhere?.

Theoretical Risk/Risk Profile

As the stock price falls, the short put loses value more and more quickly, particularly when the stock price is lower than the strike price and the chance the seller gets (early) assigned increases.

As long as the put is not assigned, the maximum risk is the strike price of the put -/- ‘net credit/premium’ if the underlying price decreases below the short put. Since the strike price can go to $0, this can be considered an unlimited risk.

Naked short put losses are proportionate to the decreases in the underlying price and require a strict adherence to risk management rules due to the theoretical risk to the downside.

Breakeven

Underlying put strike -/- net put premium/credit.

Managing and Closing Position

Halfway to/Near Expiration

If the underlying price is above the short put, the short put expires worthless with the credit as profit. If the underlying price decreases below the short put strike, there is a growing chance to be assigned (which is the goal of the cash-secured put).

Rules for Managing/Adjusting Position

• If the underlying increases above breakeven, the seller will profit.
• To adjust a short put strike when the stock price is rising, extend the duration of the position if you still want to get assigned, and roll the short put up (to around the 50 Δ put strike again AND out in time for another credit and chance to be assigned.
• Set alerts on breakeven/predetermined targets.

Rules for Closing Position/Exiting the Trade

• Suppose the underlying is trading below the strike, and you want to take ownership of the shares at a cheaper strike price (since you obtained a premium when selling the put). In that case, you can let the shares be assigned to you at or before expiry.
• Alternatively, suppose you don’t want to buy the stock anymore. In that case, profitable positions are closed by buying the option (BTC) to close following your trading rules for the target profit % of the net premium/credit received to open the position. Buy the short put option before expiration, ideally not later than 21 DTE.

Mitigating a loss

• If you don’t want the stock anymore, work with a (mental) stop loss based on an underlying asset of either 50% or 100% of the premium paid; if the underlying falls below the stop loss, exit by selling the calls.

Additional Notes

Advantages

• Cheaper than buying the stock (if exercised, you must buy the stock at a lower price, and you already received a premium).
• Gaining a regular income from rising or rangebound stocks.

Disadvantages

• Exposure to unlimited risk if the stock falls (up to $0).

Exercise/Assignment

The goal of the cash-secure put is to be assigned when the stock falls. Assignment means ownership of 100 shares of the underlying at the strike price.

You buy the stock if you are assigned at the strike price of the put.

Early assignment of a cash-secured put simply means that stock is purchased prior to the expiration date. Also, early assignment of stock options is generally related to dividends, and short puts that are assigned early are generally assigned on the ex-dividend date.