Cash-secured puts are an options strategy that lets you collect premium and potentially buy shares or ETFs at a price you’re happy to pay. Instead of buying shares at the current market price, you can use a cash-secured put to collect premium and potentially buy shares at a better price later.

How Cash-Secured Puts Work

A cash-secured put means you sell a put and keep enough cash on hand to buy the shares if they are assigned.

For example, suppose a stock is trading at $100 a share. An investor sells a put with a $95 strike and takes in a $200 premium on a contract for 100 shares.

Three outcomes are possible:

• If the stock remains above $95: the option will normally expire worthless, and the investor will keep the $200 premium without having to buy the shares.
• If the stock falls below $95: then the investor could be assigned and be required to buy 100 shares at $95 irrespective of the market price.
• If the shares go down sharply: the investor will still have to buy them at $95 and could end up with a big loss.

In this instance, the investor’s effective purchase price would be $93 per share (excluding transaction costs).

Generating Income While Waiting

One advantage of cash-secured puts is that you collect the premium while you wait for the opportunity to buy the stock.

If the option expires worthless, the investor can simply sell another put and collect another premium. Of course, the premiums will vary with the market, and there is no guarantee of recurring income.

Understanding the Risks

Cash-secured puts are less aggressive than uncovered puts because you have the cash to buy the shares.

However, the strategy has significant downside risk. If the share price drops, losses can easily exceed the premium received. The investor also gives up any potential gains if the share price rises and the option isn’t exercised.

Cash-secured puts can be incorporated into a diversified portfolio as part of an options overlay.

Rather than sitting on cash while they wait for the right investment opportunity, they can selectively sell puts on stocks and ETFs they’d be happy to own. The strike price, the expiry and the size of the position can all be adjusted to suit the investor’s objectives and risk profile.

The Bottom Line

Cash-secured puts provide a very practical way of generating some potential income as you’re buying the stocks and ETFs.

The objective isn’t just to get the highest premium. It’s about generating additional returns whilst being comfortable with the underlying investment at the strike price.

For investors with cash or cash equivalents on hand and a long time horizon, cash-secured puts can be a useful addition to a well-diversified portfolio when you select the securities appropriately and have risk management in place.