This Strategy Just Works - Cash Secured Puts
A look at opportunities to generate cash without owning a single share.
This service is for general informational and educational purposes only and is not intended to constitute legal, tax, accounting or investment advice. These are my opinions and observations only. I am not a financial advisor.
Last week was frustrating for many and downright difficult for others.
How did you feel about the price action?
Hopefully you are starting to see these pullbacks and corrections as opportunities.
That is precisely what I see.
However, taking positions during a downturn can be tricky. Even when support levels initially hold, there can be additional selling pressure dropping the price even lower.
This is an environment where utilizing cash secured puts (CSP) can be very effective and that is why CSPs are the topic of this week’s newsletter.
Quick note - if you are looking for more trading information from yours truly, here is where you can find me this week:
Wolf Financial’s Spaces
Monday 10:30 AM ET - Market Analysis
Tuesday 10:30 AM ET - Flight to Safety
Tuesday 1:00 PM ET - Savvy Trader Portfolio
Thursday 1:00 PM ET - Savvy Trader Portfolio
The Trading Triangle on YouTube
Trader Nate Trading Community
Posting Daily Trade Ideas & Commentary
Now let’s get to a few CSP trade ideas and talk a bit about why I like this strategy and ways to utilize it.
Collecting Cash and Maybe Shares
A cash secured put (CSP) is actually titled pretty appropriately. You must have enough cash in your account to buy 100 shares at the strike price of the put option you are selling.
For example, if you see XOM as a candidate to buy when shares are at $105 you may consider selling a CSP for XOM at the $105 strike price. This trade would require you to have $10,500 in your account.
This is because after selling the put you are obligated to buy 100 shares of XOM at $105 per share if the owner of the put option exercises it.
Remember that when you own an option, you can exercise it at any time. Owners of options do not need to wait for the expiration date to execute.
As the seller, you are rewarded for setting aside the $10,500 to cover the put sold with a premium you collect when you make the sale.
And you’re happy to do so because that is the price you are willing to take ownership of 100 shares of XOM.
As of Friday’s close, you could collect $205 for every $105 strike put option expiring September 8th that you sell.
That is right! You are getting paid to buy shares at the price you want to buy them at anyway.
Another way to look at it is, you’re getting a slight discount to the $105 strike price that you are willing to pay.
After taking the cash collected from selling the put options, the effective cost of the 100 shares of XOM would be offset by just shy of 2%. It drops your purchase price to $102.95 per share.
This is your effective price per share, $102.95, also known as your cost basis.
Not bad when you were willing to pay $105. Not bad at all.
If shares drop from the current $107.42 price below $105, you will not only be collecting the cash but you’ll also be buying shares. Keep that in mind!
The CSP strategy should only be utilized on stocks you are willing to take ownership of and ideally, at the price you’d like to buy at.
The chart above paints the picture nicely, with the effective price per share paid at the bottom of the recent range for XOM using the CSP strategy with this example.
Perhaps you would like to try this strategy but with a little less capital. That is where my affinity for growth stocks comes in to play.
There are several growth stocks starting to pull back a bit and some trying to form a trading range. Be sure to join the TNT Community for less than $1 per day where I outline trade ideas for over a dozen of them every week and post updates daily.
One of those names is Sofi Technologies. SOFI has been making big moves to the upside and maybe you missed the buy price you wanted.
Shares are pulling back and closed at $9.50 on Friday. I like considering buying shares between $8.50 and $9.00 but am not excited about the current share price given the volatility.
Using the CSP strategy, I can sell a put option expiring September 8th at the $9.00 strike to collect $45.
The offset provided by the premium collected gives an effective purchase price of only $8.55 which is a huge 5% discount.
I want to repeat that. The CSP is building in a 5% discount to the buy price of $9.00 which is already 5% below the current price.
SOFI would need to drop more than 10% before the seller of the $9.00 strike put options would lose money.
This is why I like the CSP strategy! The steps are simple…
Identify the level you would be willing to buy 100 shares at.
Set aside enough cash to secure the position at this price.
Sell a put option at this same price.
Collect the premium and potentially shares too!
I like to visualize, so here is the CSP strategy for SOFI on a chart. I’ve highlighted the current price, the put option strike price, and the effective price you pay per shares after considering the premium collected for selling the put option.
This is a great way to collect cash as you wait for shares to dip back into your buying range.
It is alsoa great way to stay actively trading a stock that you are patiently waiting to buy at the right price.
As with any strategy, there are drawbacks and risks so let’s look at those.
Risks Involved with the CSP Strategy
You might have already noticed that when you sell a CSP you are obligated to buy shares when those very same shares could drop much, much further than the strike price you selected and that this would be less than ideal.
This is the biggest risk you face.
It is important to review charts for levels of support, understand upcoming events like reporting earnings or product announcements, and mitigate risk before any trade.
The same is true for executing with CSPs. You must be a risk manager first and a trader second.
In the first example, XOM could drop to 90 suddenly on unexpected news. You have to assess the risk associated with potential news events and their likelihood.
Would you be ok owning shares at the $105 strike price if they did drop all the way to $90? If you had a long term thesis you might be perfectly ok with this and could even consider adding to the position to drop your average price per share.
If you would not be comfortable with this scenario, you may want to reconsider and look for other opportunities to use the CSP strategy.
The second risk is that shares do not drop at all and instead move higher. Or even worse, they move much, much higher.
Using the SOFI example, if shares take off and never come close to dropping below current levels you will have missed out on the opportunity to buy before the run up.
You will have collected premium for selling the puts, but since you never were assigned the shares you don’t get to participate in the upside.
That is the risk tradeoff for the reward of collecting cash by selling CSPs.
Trade Informed, Trade Wisely
Four of my favorite words to repeat every week. If I don’t have the information I don’t make the trade and that is how I stay out of trouble.
This trading strategy does not guarantee profits, no strategy does, but it is simple to understand and execute and does not require constant all day monitoring of your trading platform.
I like simple and effective and hopefully you find CSPs to be exactly that.
Let me know if you have any questions about this or any trading strategy I have discussed and don’t be shy about joining the TNT Community.
Have a great week trading!