Selling cash secured puts on stocks an investor is happy to take ownership of is a great way to generate some extra income.
A cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock.
The goal is to either have the put expire worthless and keep the premium, or to be assigned and acquire the stock below the current price.
It’s important that anyone selling puts understands that they may be assigned 100 shares at the strike price.
Why Trade Cash Secured Puts?
Selling cash secured puts is a bullish trade but slightly less bullish than outright stock ownership.
If the investor was strongly bullish, they would prefer to look at strategies like a long call, a bull call spread, or a poor man’s covered call.
Investors would sell a put on a stock they think will stay flat, rise slightly, or at worst not drop too much.
Cash secured put sellers set aside enough capital to purchase the shares and are happy to take ownership of the stock if called upon to do so by the put buyer.
Naked put sellers, on the other hand, have no intention of taking ownership of the stock and are purely looking to generate premium from option selling strategies.
The more bullish the cash secure put investor is, the closer they should sell the put to the current stock price.
This will generate the most amount of premium and also increase the chances of the put being assigned.
Selling deep-out-of-the-money puts generates the smallest amount of premium and is less likely to see the put assigned.
KO Cash Secure Put Example
On September 15, with Coca-Cola (KO) trading around $59.50, traders could sell a January 20 put option with a strike price of $57.50.
For selling this put, the trader would receive around $205 in option premium.
In return for receiving this premium, they would have an obligation to buy 100 shares of KO for $57.50. By January, if KO is trading for $50, or $40, or even $10, they still have to buy 100 shares at $57.50.
But, If KO is trading above $57.50, the put option expires worthless, and they keep the $200 option premium.
The net capital at risk is equal to the strike price of 57.50, less the 2.05 in option premium. So, if assigned, the net cost basis will be 55.45. That’s not bad for a stock currently trading at $59.50.
That’s a 6.81% discount from the price it was trading yesterday.
If KO stays above $57.50, the return on capital is:
$205 / $5,545 = 3.70% in 126 days, which works out to 10.63% annualized.
This trade either achieves a 10.63% annualized return, or results in buying a high dividend stock for a 6.81% discount.
You can find other ideas like this using the Naked Put Screener:
Company Details
The main downside with this trade is that Coca-Cola is currently rated a 40% Sell with a strengthening short term outlook on maintaining the current direction.
Of 10 analysts covering KO, 7 have a strong buy rating and 3 have a Hold rating.
The Coca-Cola Company's strong brand equity, marketing, research and innovation help it to garner a major market share in the non-alcoholic beverage industry. The company is making investments in healthier alternatives like coffee, sparkling water and sports drinks. The roll out of Coca-Cola Energy, Coca-Cola Plus Coffee, Powerade Ultra and Powerade Power Water are some additions on these lines. The company's portfolio includes beverage products, spanning from sodas to energy drinks. In addition to its sparkling soft drinks, the company sells a large range of still beverages including water, enhanced water, juices and juice drinks, sports drinks, ready-to-drink teas, coffees and dairy and energy drinks. Most of the company's beverages are manufactured, sold and distributed by independent bottling partners. Coca-Cola currently reports operating results under the following segments - Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; Bottling Investments and Corporate.
Summary
While this type of strategy requires a lot of capital, it is a great way to generate an income from stocks you want to own.
If you end up being assigned, you can sit back and collect the nice 2.91% dividend on offer from KO.
You can do this on other stocks as well, but remember to start small until you understand a bit more about how this all works.
Mitigating Risk
With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.
Some traders like to add a deep out-of-the-money long put to reduce risk. For example, a January put option with a strike price of 40 could be purchased for around $20. Buying this put, would cap losses below 40 and reduce total capital at risk from $5,545 to $1,565.
Please remember that options are risky, and investors can lose 100% of their investment.Â
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
*Disclaimer: On the date of publication, Gavin McMaster did have (either directly or indirectly) positions in some of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of after-hours, September 15, 2022.
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