What are the characteristics of this option strategy?
Cash secured puts are set up by selling (writing) a put option and reserving enough cash to buy the shares at the strike price if assigned. No stock is bought up front. It should not be confused with a Buy-Write, or covered call, which is buying stock and writing a call against it. This creates an income stream as the seller of the put collects the option premium upfront. The cash reserve only ensures the investor can pay for the shares if assigned; it does not limit the loss. The maximum loss is the strike price less the premium received, per share, if the stock goes to zero, which is the same downside as owning the stock from the strike price less that premium.
Is this a bullish, bearish or neutral strategy?
The cash-secured put is a neutral to bullish strategy. The investor writes a put and profits if the stock stays flat or rises, and accepts buying the shares at the strike price if it falls.
Is this a beginner or an advanced option strategy?
The cash-secured put strategy is considered to be an advanced option strategy due to its complexity. In order to successfully execute the strategy, the investor must carefully consider the option premiums available for the underlying stocks, and have a good understanding of volatility and the Greeks.
In what situation will I use this strategy?
This strategy is typically used when the investor is expecting limited upside potential in a particular stock and is looking to generate income from selling puts. It is not appropriate when the investor expects a protracted decline. A falling market makes assignment likely and the short put loses value roughly point for point with the stock below the strike. Cash-secured puts suit a flat to modestly rising market in a stock the investor is willing to own.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The reward is capped at the premium received and the risk is not symmetric with it. Setting cash aside does not hedge anything: below the strike the short put loses roughly point for point with the stock, and the maximum loss is the strike less the premium, per share, if the stock goes to zero. The probability of profit is high on any single trade, because the stock only has to stay above the strike, but the occasional assigned put can wipe out many premiums. Profitability is contingent on the investor being genuinely willing to own the stock at the strike.
How is this strategy affected by the greeks?
The cash-secured put strategy is affected by the Greeks. The Greeks are measures of the sensitivity of an option’s price to underlying market conditions like volatility, time decay, and movements in the underlying asset. The Greeks can be used to determine the optimal strike price and expiration cycle for the options in order to maximize the profitability of the trade.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The ideal volatility regime for the cash-secured put strategy would be moderate. The investor should carefully consider the volatility of the underlying stocks and make sure that the volatility is not too low, otherwise the option prices would be too low and unprofitable. If volatility is very high the premium is larger, but so is the chance that the stock falls through the strike and the put is assigned. An option expiring unexercised is the put seller's best outcome, since the entire premium is kept.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
When the trade goes against the investor, the option position can be adjusted in two main ways. Firstly, the investor can roll the position down and out to a lower strike price and extend the expiry. This can be done in order to give the stock more time to recover. Secondly, the investor can exit the position entirely by buying back the option and taking a loss on the trade. Depending on the investor’s level of skill and experience, this strategy can be relatively easy or difficult to adjust.
Where does this strategy typically fall in the range of commissions and fees?
This strategy typically falls in the range of low commissions and fees, since it is a single option contract. There is no purchase of stock at entry, so the only trading costs are the commission on writing the put and, if the put is assigned, the cost of taking delivery of the shares. The cash held in reserve is not a cost, but it is capital that cannot be used elsewhere while the put is open.
Is this a good option income strategy?
The cash-secured put is widely used as an income strategy, because the premium is collected upfront and most puts expire worthless. The income is capped at that premium while the downside is the strike less the premium, so the premium collected offsets only the first part of a decline and nothing beyond it. It suits an investor who wants to be paid for agreeing to buy a stock they already want to own, not one looking for a low risk yield.
How do I know when to exit this strategy?
The investor should monitor the underlying stock carefully to determine when it is optimal to exit the strategy. Generally, the investor should exit when the option is about to expire so as to minimize the risk of assignment and the amount of money at risk.
How will market makers respond to this trade being opened?
When the investor opens a cash-secured put strategy, the market makers will look at the price of the option, the stock price, and the volatility of the stock to determine the expected probability of the option being exercised. This will influence the price that the market makers are willing to offer for the option contract.
What is an example (with calculations) of this strategy?
For example, with XYZ trading at $20, an investor writes a 3-month put with a strike price of $18 for an option premium of $1 and sets aside $1,800 per contract to pay for the shares if assigned. No stock is bought at entry. If the stock is above $18 at expiration the put expires worthless and the investor keeps the $100 premium, which is the maximum profit on the trade. If the stock falls to $18 and the put is assigned, the investor buys the shares at $18 and keeps the $1 premium, for an effective cost basis of $17 per share. A loss only begins to accrue below $17, and the maximum loss is $17 per share, or $1,700 per contract, if the stock goes to zero. That is the same downside as owning the shares from $17, and it is many times the $100 collected.
How marketXLS can help?
MarketXLS is a great tool for traders looking to make the most of their investment strategies. It provides powerful analytical tools that allow traders to analyze the market conditions and options prices quickly and easily. It also offers a comprehensive set of tutorials so users can easily learn how to optimize their trades and maximize their profits.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
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