Strategies

A  A  A     

Cash-Secured Puts

 

Placing a Limit Order to Buy 100 ZYX at $46
vs.
Selling 1 ZYX 50 Put at $4.00

Selling an out-of-the-money put is one way to purchase underlying shares below current trading levels, but an investor might also consider selling an in-the-money put. Depending on the amount of premium received, this approach may also provide a purchase price that fits an investor's target price. One benefit of this approach is that the investor's chance of being assigned and purchasing stock is greater than from selling an out-of-the-money put. This is because the put is already in-the-money, so the underlying stock price does not need to drop for possible assignment at expiration. Another benefit is that the investor keeps a larger premium amount for selling an in-the-money put in case the stock price increases above the strike price and the option expires out-of-the-money and worthless.

Once again we will assume ZYX is currently trading at $48, and that an investor would like to own ZYX, but not at this level. He thinks that ZYX would be a good buy at a lower price, and is committed to a purchase around $46, so he sells an in-the-money ZYX 50 put for $4.00. If assigned at any time before expiration, the investor's net purchase price fits his target price: $50 strike price – $4.00 premium received = $46 per share. After the put's sale, the investor deposits into his brokerage account the full stock purchase price of $5,000 ($50 strike x 100 shares) in the event he is assigned.

Comparing each to the placement of a limit order to buy, consider four possible option expiration scenarios:

  • the stock remains above the $50 strike after the put sale, in which case the investor would not be assigned and not buy 100 ZYX shares
  • the stock is below $50 by expiration, but above the limit price of $46, in which case the investor can expect to be assigned and be obligated to buy the stock at $50
  • the stock is below $46 by expiration in which case the investor can expect to be assigned and be obligated to buy the stock at $50
  • the stock closes exactly at $50 at expiration

ZYX remains above $50 between put sale and expiration - investor not assigned



Whether by selling a cash-secured $50 put or by entering a limit order to purchase the stock at $46 per share, the investor will not buy shares and participate in a rise in the price of the ZYX stock. However, if the investor had sold the $50 put, after expiration he would retain the $400 net premium received. At that point he could either sell another put, or possibly buy the 100 shares outright, at a current price less the $400, if he feels it a good investment.

ZYX drops below 50, but remains above 46 by expiration - investor assigned.



Selling the $50 cash-secured put for $4.00 allowed the investor to buy ZYX at his net target cost of $46, even though ZYX never traded there. He has no unrealized loss on the stock purchase since $46 ($50 strike - $4.00 premium received) is his break-even point. Had he used a limit order to buy ZYX at $46, he would not have purchased any stock.

ZYX drops below 46 by expiration - investor assigned



Whether by selling a cash-secured $50 put and being assigned, or by entering a limit order to purchase the stock at $46 per share, the investor will buy 100 ZYX shares. In either case, however, the investor would have an unrealized loss on the stock purchase by the amount ZYX is below $46 at expiration.

ZYX remains above $46 after put purchase but is exactly at $50 at expiration

With a limit order to buy at $46 the investor will not buy 100 ZYX shares; by selling the $50 put he may or may not be assigned and buy the stock. If no assignment is received beforehand, the investor may or may not be assigned on this at-the-money put contract at expiration, and may not know which is the case until he's been notified by his brokerage firm on the next business day. Assigned or not, he retains the put premium received.

 
 

Previous Page Next Page

 

 

CBOE Volatility Index (VIX)