You might be surprised that a risk-averse trader like me may consider selling cash-secured puts. The thing is, selling puts can be a great way to generate income in rising markets.
As I write this piece, I find myself holding 25.62% in cash/cash-like positions in my portfolio, and it needs “a job.”
The S&P 500 is up 25% YTD, a banner year considering its annual average return of roughly 10%. Since the index is a barometer for the general market landscape, any investment matching that return is worthy. Regardless of the current market noise, I'm still bullish on the market overall.
Options is one of my favorite and most versatile financial instruments that can be used (and modified) in a particular set of situations. It also has the distinct advantage of allowing investors to access leveraged holdings unavailable to ordinary stock traders.
But, again, while options trading may expose you to higher potential gains, it also comes with higher risks. A good example of this is writing puts.
Selling/Writing Put Options
As a quick refresher, a put option gives the buyer the right to sell an underlying asset at a specified price (strike price) within a specified time frame (expiration). The seller receives a premium for selling (or writing) the put option in exchange for the obligation to buy the underlying asset at the strike price should the buyer exercise their right. This will happen if the underlying asset’s price is lower than the strike price at expiration or time of exercise.
As you can see, selling put options can potentially lead to massive paper losses. If the asset’s price plummets and you're assigned, you, as the seller, will be required to buy 100 shares per contract at the higher price than the underlying is worth, and you’d have to take a loss to close the position should you decide to sell.
That’s why most traders opt to sell put options for assets they want to own down the road—so even if they get assigned, they still get an asset that they actually want. Traders secure this eventuality by depositing enough money in their account to buy 100 shares of the underlying asset per contract sold. This is called a cash-secured put.
But did you know you can maximize your profits by securing your sold puts with another cash-like financial instrument with built-in profit?
Today, I’ll show you a neat little strategy to earn >9% by selling an at-the-money put option, and securing the trade with U.S. Treasury bills.
Strategy Breakdown
The strategy involves two financial instruments: T-bills and a put option based on a highly stable ETF you’d like to own for yourself, like the SPDR S&P 500 ETF Trust or SPY, which at the latest close trades at $595.01 per share.
A U.S. Treasury Bill (T-bill) is a short-term debt security with one year or less maturities. It is sold at a discount to face value. Investors who hold the note at maturity receive the face value,
So, as the first trade leg, I can buy $60,000 worth of T-bills expiring in just under a year. You may get as high as 98% LTV in a margin account. This can serve as a proxy for the “cash” in the cash-secured put setup.
Next, I’ll look at SPY put option prices that expire in roughly one year. To do that, I can go to Barchart.com, look up SPY in the search bar to get to the ETF’s profile page, click on Options Prices on the left-hand side, and then change the expiration date.
Now, it’s time to sell out-of-the-money or at-the-money put options for SPY. According to the options chain, I can sell $595-strike SPY puts for $30.74 per share or $3,074 per contract based on the current lowest asking price. That’s a 5.2% return. The trade will be secured with my $60,000 in T-bills.
Profit Scenario at Expiration
For this trade, I’ll earn more than 5% from writing the put option and 4.20% from buying the T-bill, bringing my total return to more than 9%.
For more concrete terms, this is the full breakdown of the trade, including the total profit:
- T-bill Discount: 4.20%
- Total Profit from T-bills (if held until maturity): $60,000 * 4.2% = $2,520
- SPY Sold Put Premium Received: $30.74 x 100 = $3,074
- Total Profit Value: $2,520 + $3,074 = $5,594
- Return Percentage Based on a $595-Strike Price: 9.4%
This return assumes that the sold put expires worthless, which is the likely scenario as the SPY generally goes up during normal market conditions. However, should the S&P 500 experience volatility and move down, the best solution is to roll the put into a lower strike. Premiums will be higher, and you’ll still be able to earn a profit.
Final Thoughts
Combining cash-like financial instruments like 1-year T-bills with a short put can yield above-average returns. However, this is a more advanced trading strategy, so, it’s best to ensure you understand the strategy fully before moving forward.
