How does cash-secured put selling work? What level of options approval do you need? This post outlines the basics of cash-secured puts, including an alternative “synthetic” play of this popular options strategy.

We’ve been fielding two questions about cash-secured put selling lately: first, what is it? And second, what level of options approval do you need to do it? In this post I’ll answer both of those, plus offer a bonus-round: there’s a synthetic options play you can try with essentially the same features as cash-secured puts.

What is cash-secured put selling? 

Let’s start with what a put is and what selling one entails. A put option gives the buyer the right, but not the obligation, to sell the underlying stock at a given price (the strike) for a given period of time (until expiration). But we’re focused on put SELLING in this post. Put sellers earn a premium in exchange for taking on an obligation to buy the underlying stock at the strike price, at any time up until the option’s expiration date.

You can sell a put “naked” or “cash-secured”, and there’s a big difference in risk between the two. “Cash-secured” put selling means you keep sufficient cash on-hand to buy the stock at the strike price; in the event you’re assigned, you’ve got that obligation covered.

When selling the put, the strike price is usually below the current price of the stock. Most traders who sell cash-secured puts are intending to buy the stock at a lower price than it is currently trading and capture the premium received from the initial put sale – call it giving yourself a little discount on a stock purchase. It’s similar to entering a limit order below the market to buy a stock you wouldn’t mind having a long position in.

Your max potential risk is substantial but limited to the strike price if the stock goes to zero. (If the puts are assigned, potential loss is changed to a "long stock" position.) Your max potential profit is limited to the premium received from selling the put. (If the puts are assigned, potential profit is changed to a "long stock" position.)

You can get the full skinny on this play under Education > The Options Playbook > Play #5 Cash-Secured Puts.

Naked put selling is much riskier. In this highly leveraged, advanced play, you are selling more puts and obligating yourself to buy more shares of stock then you have capital in the account to pay for them, if assigned. This move exposes you to substantial risk and is definitely not for beginners. Read more about the difference between naked (uncovered) puts and cash-secured puts here.

What approval level do you need for cash-secured put selling?

TradeKing’s clearing firm requires level 4 approval for all put selling, whether cash-secured or naked. If you have level 4 approval or above, yes, you can sell puts in a cash (non-margin) account or IRA at TradeKing. “Going naked” requires a margin account in which a margin deposit against your naked put is held by your brokerage firm. The deposit amount required for naked puts can change as the stock price moves, so keep this in mind if this scenario applies to you.

Why does cash-secured put selling require the same approval level as naked puts strategy?

Great question. As with many options brokerages, our clearing firm decides what level and margin is required for a specific strategy. Exchange-mandated minimums set a guideline, but many firms can and do set higher requirements for specific strategies they’ve determined need extensive trading knowledge.

TradeKing’s clearing firm Legent Clearing has decided to not make a distinction between these two short put strategies. They have determined to sell any put option without buying another put as a hedge (i.e. a vertical or horizontal spread) requires extensive trading knowledge, consistent with level 4 options approval.

This is their view on the risk involved, and it’s within their rights to set the trading level. But don’t worry: if you have a lower approval level because of limited option trading, there’s a way you CAN approximate this trade synthetically. This alternate strategy will give a very similar risk/reward scenario as the cash-secured put, but with a lower approval level.

Can you trade your way around this restriction? Yes, synthetically.

To “synthesize” the risks and rewards of a cash-secured put, you can sell an in-the-money covered call (ITM). This move requires only level 1 options approval, but results in a position with a similar risk-reward scenario as selling a cash-secured put.

Selling (or “writing”) a covered call involves selling a call option on an underlying stock for no more than the number of shares you already hold. Covered call writing can earn you a little income on a stock that may be trading sideways, or it can be a way to sell your stock after it’s risen in value, while making additional profit by selling the calls. Should you get assigned on the call sale and be required to deliver the shares, you’re “covered” because you already have those shares in readiness.

Commission-wise, it’ll cost you $5.60 to sell 1 covered-call contract and another $4.95 commission to buy or sell the underlying stock shares. If you’re assigned, that incurs a flat $4.95 charge, while closing out the leg after assignment requires an additional $4.95, if you choose to do that.

The max potential profit of a covered call is limited to the strike price minus the current stock price, plus the premium received for selling the call. The max potential risk comes from owning the stock, which can theoretically drop in value to zero. However, selling the option does create an “opportunity risk.” That is, if the stock price skyrockets, the calls might be assigned and you’ll miss out on those gains.

A “synthetic” options position is created by combining different financial instruments to simulate another kind of position. Market-makers use synthetic positions all the time, whenever they’re forced to take a trade that doesn’t fit well into their other positions. You can learn more by logging into your TK account and checking out our educational video on synthetic option positions.

Regards,
Brian Overby
TradeKing's Options Guy
www.tradeking.com

[image: Mossy Mailbox by jenny818 on Flickr]

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options available at http://www.tradeking.com/ODD.

Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.  

Supporting documentation for any claims made in this post will be supplied upon request. Send a private message to All-Stars using the link below the profile image.

TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.

(c) TradeKing, Member FINRA, SIPC. http://www.tradeking.com

Wiggy, you could/would be required to by the stock at the strike price even if it goes to zero.

Brian, your synthetic doesn’t sound to good to me.  If I were allowed to write a covered put it would be to obtain the stock at a lower price (strike-premium) or keep the premium as a percentage of my investment.

Buying the stock outright and selling an ITM call puts me at risk of the stock falling in price or it getting called away if it rises.

I wish TK and Legent would reconsider the option level for covered puts.

El Dorado said:

Wiggy, you could/would be required to by the stock at the strike price even if it goes to zero.

 

 Yes, you are correct, El Dorado. I usually only write covered puts with the current month's expiration or the next one out.

My apologies Brian,

I should have done a little more research first. Never gave much thought to someone selling puts as a speculative strategy, TK is not alone in restricting this behavior.

Wiggy said:

Buy writing covered puts, I would think the risk is substantially less since the cash is in the account and it's the buyer who's holding the stock.  If the stock drops to zero, the writer loses nothing. Not so in writing covered call positions. Just a thought.

Hello Wiggy,

I am not sure if I understand completely. First, I am assuming you consider "writing covered puts" the same as "cash-secured puts" and you are just using a different name for it. If you sell a put you take on an obligation to buy the stock at the strike. So if the stock went to zero and you had sold a put the you would be assigned and have to buy the stock at the strike. Hence you would own the stock at a much higher price then it is currently trading.  So I disagree with your statement "If the stock drops to zero, the writer loses nothing." This comparison (cash-secured puts vs In-the-money covered calls) is explained in detail in the the blog titled “synthesize cash-secured put selling? Here’s how."

Regards,
Brian (Og)

I would also suggest an alternative to selling a cash secured put which is simply to sell a Put Spread.  This does require Level 3 approval but would probably be more typical of what most option traders are approved for at Tradeking.  Depending on the strike prices available for a particular stock, you can sell a put spread and have it be very equivalent to  a naked put by simply buying a put as far out of the money (the smallest strike) as you can find to hedge the put you sold that is closer to the money.  Look for the lowest strike put in the options chain and often it will be going for only .05 to .10.  This would however add an additional commision charge but so does selling an in the money call because you have to purchase the stock.  And the out of the money put spread is more likely to expire worthless, while the in the money call is more likely to be assigned at expiration which adds another commission charge.

Check the forums for an example of a synthetic play of this type. Type in PARD in the search box. I am using the synthetic and another member is using the cash secured put.