Understanding Cash Secured Puts: A Smart Strategy for Income and Stock Acquisition

Options trading gives investors numerous income-generating strategies, from new traders to those always ready to go big. The most recognizable of these are covered call and cash-secured put strategies but a bit less aggressive on the latter strategy gives an opportunity for the trader to have premium income while giving them the option to buy the stock at lower prices if necessary. In this article, you will find everything you need to get started with cash-secured puts — illustrated through examples of the strategy, potential outcomes that could emerge from them, and a comparison to other popular options trading strategies.

What Are Cash Secured Puts?

A cash-secured put is an options selling strategy whereby an investor sells a put option on any stock at the same time he or she has sufficient cash in his or her brokerage to cover purchasing the stock if exercised. A put option is one of the two types of options available in options trading — meaning it allows the buyer of the option to sell securities to the writer (or seller) of the option at a specific price for a limited amount of time, specifically, until these options expire. In the case of cash secured put, since the investor has already delivered this full amount of cash to the option buyer (and is therefore able and willing to buy shares if the option buyer chooses to exercise; he takes upon himself that obligation)

This arrangement allows the investors to obtain cash flow way upfront diluted from paid based on deep pocket also about which shares will need to be spent. Specifically, if the market price of the stock is above the strike price at expiration, the option may expire unexercised and you as a seller will get to keep your received premium without having to buy the shares. If the price is below the strike, the investors receive a message to take the stock and the investor buys at the strike price which may put long-term investors in a much better position when it comes to purchasing that particular stock at a lower price.

Key Terms in Cash Secured Puts

• Strike Price: The price, which both the option seller and buyer have agreed on at which the option seller may be forced to purchase the stock.
• Premium: The amount the option seller collects at the time of selling the option and which makes him/she responsible to potentially purchasing the stock.
• Expiration Date: The later of the date when the option will be exercised or the date those options will expire.

Because of the features described above, cash-secured puts will suit better value investors who crave for additional income under the condition that they are ready to purchase shares at a moderate price.

Possible Outcomes for the Put Seller: Scenarios to Consider

The outcome of a cash-secured put, therefore, depends on where the price of the particular stock is, compared to the ₹1,400 strike price when it is expiration time. Here are potential scenarios for this trade:

Scenario 1: BSE Large Cap Stock Continues to Trade Above ₹ 1,400

If the stock price of Prominent remains above ₹1,400 until the option expires, the put option will likely go unexercised. Since the price never gets to the strike price, then the buyer does not have a reason to exercise the option and you collect the premium as your full gain. This result is in the best interest of the seller who gets the premium without having to purchase the stock.

• Outcome: The ₹4,000 collected as a premium is retained as profit by you.
• Total Return: You retain 100% of the premium as profit, with no additional capital required

Scenario 2: Leading Stock Takes Dip Below ₹1,400

If Prominent’s stock price falls below ₹1,400, the buyer may exercise the option, obligating you to purchase the shares at the strike price. For instance, the price of the stock reduces to ₹1,350. Though the stock costs ₹1,400, which may initially seem unfavourable compared to the market price, the premium reduces your effective cost to ₹1,360 per share, partially offsetting the market decline.

• Outcome: You acquire Prominent shares at ₹1,400 with cost basis of ₹ 1,360.
• Long-Term Potential: If Prominent is a company you want to have an ownership stake in, this is your chance to get it at a lower cost, more so if there are chances that the stock will rebound in future.

Scenario 3: Prominent Stock Nears ₹1,400 at Expiration

At this time it is unclear whether the option will be exercised if the stock price is close to ₹1,400 at the expiration date. Let’s assume Prominent has closed at ₹1,410. The put option is not exercised and one exchanges it for a share but does not purchase the shares at all while getting to keep the amount of premium paid. This scenario is still favourable because you have also made revenues from the premium and also managed your cash.

• Outcome: You keep the premium of ₹4,000: even your initial cash remains with you.

Why Buyers Might Prefer Cash-Secured Puts for Stock Acquisition?

As it will be seen from the buyer’s side, employing a cash-secured put strategy involves a method of obtaining the preferred price for the shares. In India, this strategy is well-suited for acquiring blue-chip stocks, allowing long-term investors to potentially purchase quality shares at a lower cost. If the value in the market decreases, the option enables the buyer to purchase the shares therein at the strike price rather than the cash market price, which will certainly be higher. If the price is high they abandon the option but have cost only the premium and hence have taken a Controlled Entry Strategy into the market.

Payoff Structure for Cash-Secured Puts. Note: The following examples do not guarantee specific outcomes and are for illustrative purposes only.

The payoff structure for a cash-secured put is described in the following table referring to our Prominent example:

Stock Price at Expiration	Action Taken	Premium Earned	Effective Stock Purchase Price	Net Profit/Loss
₹1,500	Option Expires	₹4,000	N/A	₹4,000 Profit
₹1,400	Option Expires	₹4,000	N/A	₹4,000 Profit
₹1,350	Assigned Shares	₹4,000	₹1,360	-₹10,000 Loss

 

Cash Secured Puts vs. Covered Calls: Key Distinctions for Indian Investors

Cash secured put and covered call both provide Indian investors opportunity to get regular income and take care of stocks. Here’s how they differ:

1. Cash Secured Puts: Investors agree to buy a stock at a set price, earning premiums from selling put options and preparing to buy shares at the agreed-upon price if exercised.
2. Covered Calls: Here, investors who already hold the stock will sell a call option on it, collect income and sell the stock if the actual price of the stock soars above the strike price.

Implementing Cash Secured Puts: Is It Right for Your Portfolio?

Cash secured puts are very straightforward and make up a sensible income strategy for Indian investors. Here are a few considerations to ensure this approach aligns with your portfolio goals:

1. Financial Preparedness: Be able to have enough cash on hand to conduct the purchase of shares if the situation arises.
2. Investment Goals: This is a perfect strategy with a long-term investment horizon in fundamentally sound stocks.
3. Market Analysis: Consider market volatility, stock conditions, and the strike price to avoid over-leveraging in downturns.

Final Thoughts

Cash-secured puts offer a balanced, income-generating option strategy for Indian investors looking to purchase stocks like Prominent or Tata Steel at discounted rates while earning premiums. This strategy is especially valuable for those who want to invest conservatively, using options to acquire shares in high-quality companies over time. With thoughtful planning, cash-secured puts can be a beneficial addition to an options-based portfolio, enabling strategic stock acquisition at preferred entry points in the Indian market.

• Author: Religare Broking
• Last Updated: December 4, 2024