Cash Secured Put Strategy – Buy Stocks at Your Target Price

Are you looking for a new way to increase the returns in your portfolio? Would you like to buy additional stocks, but the current prices of your preferred candidates are simply too high? Perhaps this "Cash Secured Put" options strategy will appeal to you. It belongs to the advanced investment strategies and requires a basic understanding of trading options in the financial market. In return, this investment method opens up new possibilities when buying stocks, as you act as the option writer.

 

How does the Cash Secured Put strategy work?

• You want to expand your stock portfolio and have sufficient cash in your account (e.g. euros or dollars) to buy 100 new shares of your favorite company. However, you currently find the share price too high.
• Your general expectation is that this stock will rise somewhat in the near future or at least move sideways.
• You decide to sell a put option on this stock (also called "writing an option") in order to earn money as the option writer through the option premium. You set the strike price slightly below the current price, ideally at the price you would be willing to pay for this stock. As the seller of the put option, you must guarantee at any time during the term that the option buyer can sell you these shares at the agreed price (strike). Since you have deposited and reserved the money for the 100 shares in your account (hence the name "Cash Secured Put" or "secured sale" — the cash is available), you are not taking on a particularly large risk. 

 

Simple example of the Cash Secured Put strategy

 

The initial situation

• In this example, we assume that you want to buy 100 Volkswagen shares (VOW3) and have the money available in your brokerage account.
• The current price of the Volkswagen share is €164.48 (as of 10.02.2021). However, after your company and price analysis, this value is a bit too expensive for you — you would be willing to buy the shares at a maximum price of €140.
• Since you do not necessarily expect a larger price drop in the near future, you are looking for another way to still invest in Volkswagen.

Image source: Google search "vw aktie"

You decide to act as an option writer using a put option and generate additional income. You ask your broker to display all current price values for put options on the VW share (here is an example screenshot from the TraderWorkstation by Interactive Brokers):

 

Table with current price data for call and put options

• As the term of the put option, you choose, for example, 219 days, in this example until September 17, 2021. This covers a good half year.
• So that you only have to take delivery of the 100 shares at a price that is fair or acceptable to you, you decide on a strike (base price) of €140. Since you want to sell the put option (acting as the option writer), you would have to buy 100 Volkswagen shares from the option buyer at €140 per share if they exercise the option.
  Note: One options contract always refers to 100 shares here.
• Your goal is either to make a profit through the option premium from the sale, or in the event of a price drop, to buy 100 Volkswagen shares at a price that is fair to you. As the table in the example shows, the bid and ask prices are in the range of €8.35–€8.75; realistically, you may be able to sell the option at a price of €8.55.

 

What profit can you make and what can happen with the options trade (at the end of the term)?

You have written a put option with a strike of 140 on the Volkswagen share, with a term of 219 days. The official notation of the financial instrument would be:

VOW3 IBIS (VO3) Sep17'21 140 Put

Your limit order for the option price of €8.55 was successful and you immediately received the option premium of 8.55*100 = €855 credited to your account (minus broker commission, ignored here).

The option buyer can exercise the option at any time during the term until September 17, and you would then have to buy their 100 Volkswagen shares at a price of €140 per share. As long as the buyer can sell the shares on the "regular" stock market for more than €140, they will sensibly not exercise their option.

Until the end of the term, two scenarios remain for you, depending on how the Volkswagen share price develops:

1. VW share price stays above the strike value of €140, the option is not exercised

• At the end of the term, the option expires worthless (it is not exercised, since the buyer could sell the VW shares more expensively on the "regular" stock market).
• You can keep the premium of €855 (minus broker commission), but you have not received any Volkswagen shares. Writing the option was very worthwhile for you.
• It should also be mentioned that a potential additional gain compared to a direct share purchase may have been missed if the Volkswagen share rose extremely. Your profit is limited to the amount of the option premium, but the increase in the share's value due to the price rise can be significantly higher.

 

2. VW share price falls below the strike value, the option is exercised

• At the end of the term, the Volkswagen share price has developed worse than you expected and has fallen to, for example, €130. The option buyer will therefore exercise the option and sell 100 Volkswagen shares to you at €140 per share = €14,000).
• Since you are buying the shares at a price of €140 and not at the then-current price of €130, your portfolio will initially show a loss for the 100 Volkswagen shares of €140 - €130 = €10 per share, i.e. a total of €1,000 (plus broker commissions, ignored here). This loss is of course only realized if you decide to actually sell the shares again.
• You can keep the premium of €885 (minus broker commission), so your current loss is reduced to €1,000 - €885 = €115 (broker commission ignored here!).
• Because the share has fallen, you have made an overall loss on the transaction. However, since you are allowed to keep the option premium, the amount of the loss remains manageable and you are in a better position than if you had bought the shares directly at the then-current price of €164.48.

 

 

Advantages of the Cash Secured Put options strategy

• You can also achieve an additional, attractive return through option premiums even when share prices are moving sideways or falling slightly.
  
• You get the opportunity to buy shares only when the price falls. Nevertheless, you don't walk away empty-handed if the share continues to move upward.
• One could say that you are being paid for waiting until your shares move to your desired price.

 

Disadvantages of the Cash Secured Put options strategy

• If the price falls very sharply, you will initially have shares booked into your portfolio that are at a loss.
• If the price rises extremely sharply, you do not benefit additionally from this. Your profit is limited to the amount of the option premium.
• Since one put option contract generally applies to 100 shares, this strategy does not work if you want to buy fewer than 100 shares. As a result, certain extremely expensive shares may be out of reach for some investors.

 

Tips for combining: Covered Calls & Cash Secured Puts

With the put strategy, you have an attractive option to book shares into your portfolio at a more attractive price in the event of a potential price decline.
If the shares do not fall, the options expire worthless and you keep the option premium as additional income.
Tips for combining the call and put strategy:
If new shares have been booked into your portfolio through the execution of the put option, you can generate additional income from your shares with a covered call option. In doing so, you should always make sure to choose the strike for the call so that it is above your purchase price.

 

 

Sources and interesting links

1. mission-cashflow.de - Options trading ABC: The Cash Secured Put
2. eichhorn-coaching.de - Buying shares at your desired price with a Cash Secured Put

 

Do you have any further tips on options strategies with maximum return potential? What are your experiences with derivatives and options trading? Feel free to leave a comment.

 

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