Getting paid while you wait, I like the sound of that.
A cash secured put is a conservative options strategy that can be used to purchase a stock for lower than the current price.
Let’s say you’re happy to buy AAPL at $173. You’re definitely going to be happy to buy it at $165.
Let’s work through an example.
A trader wants to buy APPL shares, but wants to wait for a minor pullback before getting involved. With the stock trading at $173.09, the trader wants to wait until it hits $165 before making a purchase.
Instead of waiting for a pullback (which may never come), the trade can sell a cash secured put with a strike price of $165.
The April 21st, $165 puts are currently trading for $3.20, so by selling this option the trader collects $320. He also has an obligation to buy AAPL at $165. It’s important to remember that even if the stock drops to $100 between now and April 21st, the trader still has to buy APPL for $165.
Let’s say AAPL does fall below $165 and the trader is assigned 100 shares. The total cost would be:
100 x 165 – 320 = $16,180.
This gives an effective purchase price of $161.80.
Not only do you need to be okay with purchasing the stock at this price, you need to have the money reserved to make the purchase.
Which Month Should You Sell?
In this example the trade was happy to buy AAPL for $165, but which month should he use? We used April in the example, but what if we chose a longer or shorter timeframe?
Option premiums will be more expensive the further out in time you go, but the rate of time decay will be slower and the annualized return will be lower.
Let’s compare April and November to illustrate the point.
The April put is trading for $3.20 and the November put is at $10.05
If AAPL stays above $165 and the puts expire worthless the returns will be as follows:
April $165 put – 1.94% or 11.06% annualized
November $165 put – 6.09% or 8.14% annualized
