Selling cash-secured puts is one of the go-to strategies in the BCI methodology. There has been some confusion for some of our members who conflate this strategy with covered puts, a completely different strategy. This article will define and compare the two strategies.
Selling cash-secured puts defined
A put option (generally out-of-the-money) is sold against an underlying stock or exchange-traded fund. The trade is “secured” by placing an appropriate amount of cash in our brokerage account to pay for a potential future stock trade (if the shares are “put” to us resulting from option exercise). The formula for the cash required is as follows:
[(put strike – put premium) x 100] x # of contracts
Calculations using the BCI Elite Put-Selling Calculator using a hypothetical trade with BCI
Put-Selling Calculations
- 3/18/19: BCI trading at $50.00
- 3/18/19: Sell the 1-month $45.00 (out-of-the-money) put for $2.00
- Cash required to secure the put per-contract = [($45.00 – $2.00) x 100] x 1 = $4300.00
- Initial time value return on the option = 4.65%, 53.05% annualized
- Breakeven (maximum loss) is $43.00 per share
- If shares are “put” to us, it will be at a 14.00% discount from share value at the time of the trade
Covered puts defined
This is a bearish strategy where a stock is shorted (borrowed from broker and then sold). A put option is also sold on the same underlying security. The sale of the put generates some immediate income but the profit from the short stock position is limited by our obligation to buy the shares at the put strike.
Hypothetical covered put trade with BCI
- BCI is trading at $50.00
- Short sell BCI at $50.00
- Sell the $45.00 put for $2.00
Maximum loss is unlimited
Theoretically, share price can rise to infinity creating a disaster with the short stock position. This why most retail investors should avoid shorting stocks and why this isn’t an appropriate strategy for most of us. The put premium will slightly offset losses from the short stock position. Let’s exaggerate with a scenario where stock price moves up to $100.00 per share.
- Stock position loses $50.00 per share (sold for $50.00 and purchased at $100.00…ouch!)
- Put sale generated $2.00 per share
- Net loss is $48.00 per share
Granted this is an exaggerated example but I hope it makes the point.
Maximum gain is the difference between the put strike and short stock price plus the premium received
If share price declines to the put strike or lower, we buy the shares at $45.00, our put obligation. Since the shares were sold (shorted) at $50.00, this represents a $5.00 per share profit. Now we add the $2.00 put premium for a total net profit of $7.00 per share.
Breakeven is the short position cost-basis plus the premium received
In this hypothetical, if share price rises to $52.00, we lose $2.00 per share on the stock side (Buy at $52.00 after selling at $50.00). This negated by the $2.00 per share put premium received from selling the short put.
Discussion
Selling cash-secured puts is a completely different strategy from covered puts. The latter involves shorting stocks which should only be considered by experienced, sophisticated investors and requires a much higher level of trading approval. Selling cash-secured puts is a low-risk option-selling strategy that is appropriate for most retail investors once the 3-required skills (stock selection, option selection and position management) are mastered.
Educational products for selling cash-secured puts
https://www.thebluecollarinvestor.com/alan-ellmans-selling-cash-secured-puts/
https://thebluecollarinvestor.com/minimembership/elite-put-selling-calculator-2/
New covered call writing DVD program now available with early-order $50 discount
Our objective was to create the most complete and comprehensive video program on covered call writing found anywhere. The 4-set video curriculum takes us through the 3-required skills: stock selection, option selection, and position management. The 4th section highlights special circumstances like writing calls against long-term buy-and-hold portfolios.
You Will Learn:
– How to locate the greatest performing stocks for option-selling
– Which Is the best option to sell
– How To calculate your returns
– How To utilize exit strategies – Decrease losses & enhance gains
The program is based on 25 years of actual trading options, not on computer models. All the rules and guidelines presented are based on these real-life experiences. This series will benefit both beginners and more experienced investors and addresses all scenarios that can arise before, during and after trade executions.
https://thebluecollarinvestor.com/minimembership/covered-call-writing-package-4-dvd-series-workbook/
Use this promo code for a $50.00 discount off the $149.00 price:
newdvd50
The program also includes a downloadable workbook.
Your generous testimonials
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
Encyclopedia book review on Amazon.com:
Thank you Dr. Ellman. Great book… Dr. Ellman is a great writer. He did well in describing a very difficult topic. Writing a book on exiting positions is brilliant. All derivative traders need to read this book.
Thanks,
Dr. A
Upcoming event
August 15, 2019: San Francisco Money Show
9:15 AM – 12:15 PM
3:15 PM – 4 PM (Free and streaming online)
***********************************************************************************************************************
Market tone data is now located on page 1 of our premium member stock reports.
***********************************************************************************************************************
Alan,
Thanks for another informative article. You explain that covered puts is a bearish strategy. What about cash-secured puts. Bullish or bearish?
Thanks,
Marsha
Hey Marsha,
My two cents is selling cash secured puts is bullish. I do it all the time when VIX is higher than average like now, options prices are up and I do it on the big wash out down days when put values go up so I get better premium. I always sell the puts below current market (OTM) on things I would not mind owning in case price sinks further and I get assigned.
If price rises and the puts expire worthless that’s fine too. The money did far better than it would have at the bank 🙂 – Jay
.
Marsha and Jay,
I sell puts in both bull and bear markets. In bear markets I choose strikes that are further out of the money to make my breakeven lower. Been doing well with this approach. I also sell puts before buying any stock an idea I got from Alan’s put book.
Susan
Thanks Susan,
I am much the same way. I don’t trade my long term account with great frequency but if I see a stock that scratches my itch I like to sell CSP’s OTM on weakness first and see what happens.
I am not Karnac but this is the time for seasonal weakness in stocks so CSP’s on stuff you like on the big down days OTM makes sense to me here as opposed to buying new stocks just to see them get hammered. – Jay
Thanks Jay and Susan!
I agree that a good approach in the current market is to sell OTM puts before buying a new stock.
Good luck to all.
Marsha
Alan,
When selling Cash Covered Puts, you recommend that when the underlying share price falls 3% below the strike price, and it is more to do with the individual stock and not the overall market, it is recommended to buy back the put option.
In reading your Complete Encyclopedia for Covered Call Writing, I don’t see the same recommendation for Covered Calls. (Of course both do have the same 20%/10% of premium buy back option exit recommendation.)
For covered calls, do you recommend buying back the call option if the underlying share price falls 3% below the strike price, if the drop is due more to the individual stock and not the overall market? If no, why not?
Chris
Chris,
My responses:
1. For covered call writing, since we are in 2 positions (long stock, short option), every exit strategy starts with buying back the option. Using the 20%/10% guidelines assists us in when to execute these trades. At that point we have several choices to select from since we are still shares owners (wait to “hit a double”, roll down, sell the stock). It’s not always “sell the stock”
2. For put-selling, we do not own the stock (but are obligated to do so) and use the current market value to determine whether to stay in a position or close. The 3% guideline (you described quite well) will keep us out of trouble on a stock under-performing the overall market.
3. The 20%/10% guidelines relates to a declining stock for covered call writing and an accelerating stock for put-selling. In the former, we are mitigating possible losses and in the latter, we are looking to generate more than a maximum return for the cash investment. For put-selling, the 20%/10% guidelines is analogous the “mid-contract unwind” exit strategy for covered call writing… same name, different circumstances.
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 08/09/19.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/
Best,
Barry and The Blue Collar Investor Team
[email protected]
Warning to all,
GLOB has cofirmed ER on 08/15, after the bell, one day before expiration Friday.
Roni
Hello Alan,
Love your newsletter! Thank you for your teachings.
Question.
I’ve been selling slightly out of the money covered calls about 7-days out on $150,000 in my IRA on stocks AAPL, STZ, MFST, V, HD & PM.
It’s been going great so far! I’m earning about $20-$30 per day in 10 contracts. That’s almost $100K a year in premium! What’s the catch? (is this sustainable?)
Question.
Is there anyway to protect our downside using this strategy?
Should I hold 30% cash? Buy the inverse QQQ fund?
Thanks for your help.
Scott
Scott,
A 67% annualized return is highly unlikely. I’ve come close to 50% a few times in 25 years of selling options and those were in strong bull market environments.
However, we should beat the market every year and the reason is that by selling options against our shares, we are lowering our cost-basis (breakeven). Mastering the 3-required skills will elevate our returns to the highest possible levels.
Downside protection for covered call writing includes using in-the-money strikes and protective puts. We can also sell out-of-the-money puts before entering our covered call positions. All this information is detailed in my books and DVDs.
The inverse QQQ Fund (PSQ) is appropriate for strong and confirmed bear markets. I do not believe we are even close to being there now but for those who do, this security would be a great choice to consider.
Keep up the good work.
Alan
Alan,
When you roll options do you buy back and sell new in 2 separate orders, or do you use ‘buy/write’ as a single order?
I always had some cash reserve in my trading account and used to roll options in 2 separate orders placed within few seconds, but I’m not sure if this is correct. I noticed that when submitting separate orders you can get filled at slightly better price. I use ‘midpoint’ of bid/ask price and it gets filled very often with separate orders, but with single orders in most cases it doesn’t go through. However comissions seems to be lower when using single ‘buy/write’ order.
What are advantages/disadvantages of these two in your opinion?
Sunny
Sunny,
I roll in 2 steps for the very reason you stated. We can leverage the “Show or Fill Rule” more effectively for better pricing. There may be scenarios with certain brokerages (depending on its commission structure) to roll with one net credit or debit limit order.
Alan
Hi Alan,
just a quick question: When selecting options for ETFs, do you stick to the one month time frame, or do you go shorter, for instance 1 week?
Thanks for your attention.
Regards
Dietmar
Dietmar,
I firmly believe that we can consistently beat the market with both Weeklys and Monthlys. This applies to both stocks and ETFs. My personal preference is for Monthlys. See the file in our member site (resources/downloads section) on the pros and cons of Weekly options (scroll down to “W”).
Alan
See one of my San Francisco presentations live this Saturday. To register for free click here:
https://conferences.moneyshow.com/moneyshow-san-francisco/live-stream/registration/?scode=047697
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan