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.
WFC Cash Secure Put Example
Earlier today, with WFC trading at $45.10, the October put option with a strike price of $42.50 was trading around $1.05. Traders selling this put would receive $105 in option premium. In return for receiving this premium, they have an obligation to buy 100 shares of WFC for $42.50. By October 20, if WFC is trading for $40, or $30, or even $10, the put seller still has to buy 100 shares at $42.50.
But, if WFC is trading above $42.50, the put option expires worthless, and the trader keeps the $105 option premium. The net capital at risk is equal to the strike price of $42.50, less the $1.05 in option premium. So, if assigned, the net cost basis will be $41.45. That’s not bad for a stock currently trading at $45.10. That’s an 8.09% discount from the price it was trading yesterday.
If WFC stays above $42.50, the return on capital is:
$105 / $4,145 = 2.53% in 78 days, which works out to 11.70% annualized.
Either the put seller achieves an 11.70% annualized return or gets to buy a blue chip stock for an 8.09% discount. You can find other ideas like this using the Naked Put Screener. Below you can see some parameters that you might consider for running this screener. Feel free to tweak them as you see fit.
Company Details
The Barchart Technical Opinion rating is a 72% Buy with an average short term outlook on maintaining the current direction.
Of 16 analysts covering WFC, 7 have a Strong Buy rating, 2 have a Moderate Buy rating and 7 have a Hold rating.
Wells Fargo & Company is one of the largest financial services companies in the U.S. The company provides banking, insurance, trust and investments, mortgage banking, investment banking, retail banking, brokerage services and consumer and commercial finance through more than 4,700 retail bank branches, broad automated telling machines (ATMs) network, the Internet and other distribution channels globally. It has 4 segments. Consumer Banking and Lending offers products and services like checking and savings accounts, credit and debit cards, as well as home, auto, personal and small business lending to consumers and small businesses. Commercial Banking provides banking and credit products across industries, and treasury management. Corporate and Investment Banking delivers services related to capital markets, banking and financial products. Wealth and Investment Management provides personalized wealth management, brokerage, financial planning, lending, private banking, trust and fiduciary products and services.
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 2.60% dividend on offer from WFC. 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.
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.
