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.
Disney Cash Secure Put Example
Disney (DIS) is a blue-chip stock and is also the second most oversold stock in the Dow Jones Industrial Average according to the RSI reading.
Yesterday, with DIS trading at $96.95, the August put option with a strike price of $90 was trading around $1.12. Traders selling this put would receive $112 in option premium. In return for receiving this premium, they have an obligation to buy 100 shares of DIS for $90. By August 16th, if DIS is trading for $85, or $80, or even $50, the put seller still has to buy 100 shares at $90.
But, if DIS is trading above $90, the put option expires worthless, and the trader keeps the $112 option premium. The net capital at risk is equal to the strike price of $90, less the $1.12 in option premium. So, if assigned, the net cost basis will be $88.88. That’s not bad for a stock currently trading at $96.95. That’s an 8.23% discount from the price it was trading yesterday.
If DIS stays above $90, the return on capital is:
$112 / $8,888 = 1.26% in 37 days, which works out to 12.43% annualized.
Either the put seller achieves an 12.43% annualized return, or gets to buy a quality stock for an 8.23% discount. You can find other ideas like this using the Naked Put Screener.
Company Details
The Barchart Technical Opinion rating is a 56% Sell with a Average short term outlook on maintaining the current direction.
The market is in highly oversold territory. Beware of a trend reversal.
Of the 27 analysts covering DIS, 18 have a Strong Buy rating, 4 have a Moderate Buy rating and 5 have a Hold rating.
Walt Disney Company has assets that span movies, television, publishing and theme parks. In October 2020, Disney reorganized its media and entertainment operations, which had been previously reported in three segments: Media Networks, Studio Entertainment and Direct-to-Consumer & International. From the first quarter of fiscal 2021, Disney began reporting the financial results of the media and entertainment businesses as one segment, Disney Media and Entertainment Distribution (DMED) across three significant lines of businesses: Linear Networks, Direct to- Consumer and Content Sales/Licensing.
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 start selling covered calls while waiting for the stock to recover. 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.
Risk averse traders might consider buying an out-of-the-money put to protect the downside.
Please remember that options are risky, and investors can lose 100% of their investment.
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.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
