The current yield on the S&P 500 is hovering at an anemic 1.30%, hardly ideal for investors who rely on yield.
Selling puts on a stock you want to own is one way to generate an income using options.
What is a cash-secured Put?
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.
A cash-secured put is a slightly less bullish trade than buying the stock. It is considered a neutral to slightly bullish trade.
Selling put options is an easy place for investors to start with options. They are very similar to a covered call and are quite easy to understand once you know the basics.
Anyone selling puts must understand that they may be assigned 100 shares at the strike price.
The mechanics of the trade
Let’s take a look at an example using AAPL stock.
With the stock trading at 147 on Friday, investors could sell a November 19, 2021 put with a strike price of 140 for around $3.35.
An investor selling this put would receive $335 into their account, which would be theirs to keep. If Apple falls below 140 by November 19, they would be required to buy 100 shares at 140. The effective net cost of the position would be 136.65, thanks to the option premium received.
That’s 7.04% below yesterday’s closing price.
If the stock stays above 140 at expiry, the put expires worthless, leaving the trader with a healthy 2.45% return on capital at risk. That works out to around 17% on an annualized basis.
Some traders may prefer to wait and see if Apple stock pulls back, in which case the November 140 strike put could be sold for a higher price. Alternatively, traders could sell a lower strike put.
The main risk with the trade is similar to outright stock ownership. If the stock falls quickly, the trade will suffer a loss. However, the loss will be partially offset by the premium received for selling the put.
The maximum loss on the trade would occur if AAPL fell to $0, seeing the trade lose $13,665, but most traders would cut losses long before then.
Final thoughts about this trade idea
Cash secured puts are a wonderful way to generate a healthy return on strong stocks, potentially without ever having to take ownership.
If the put does get assigned, the investor takes ownership with a reduced cost base and can potentially begin selling covered calls to generate further income from the position.
*Disclosure: On the date of publication, Gavin McMaster did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. The information herein is based solely on my personal opinion and experience. All investments hold inherent risk, and the information provided should not be interpreted as any kind of guidance, recommendation, offer, advice, or suggestion. Any ideas and strategies discussed on this channel should not be implemented without first considering your financial and personal circumstances or without consulting a financial professional.