How To Tweak Your Cash-Secured Put Trades

Introduction: Buying Stock At A Discount

Let's say you'd love to buy stock X, but you want to get it a little bit lower in price. What you could do is setting a limit order, however, if you can set a price that you're willing to pay for the shares and get paid for undertaking that obligation that's a sweeter deal... Let's look at a real-life example and elucidate all the mysteries behind selling cash-secured puts.


Case Fagron

Consider Fagron, listed on Euronext Brussels for a moment. Two weeks ago, I received a question related to selling cash-secured puts on this particular stock. When selling cash-secured puts, the most intuitive way to do it: selecting an out-of-the-money put, or lower than current market value. But what if you're bullish on the stock and don't mind being assigned at the end of the contract period at a price higher than current market value? Does that make any sense for the smart investor?

We see strong upward momentum with the price possibly breaking out to €22.80. So what do we do if you want to buy the stock? First, we have to access the options chain with - at the time of making the screenshot - 51 days to expiration.


The €20 put

The following bullet points tell you everything you need to know about this out-of-the-money put:

  • Downside protection of the profit: 54 cents per share or €54 per contract (this applies only to out-of-the-money puts)

  • Breakeven: €19.42 (strike price minus total premium)

  • Amount of cash required that you have to set on the sidelines to meet a possible future stock transaction: (strike price minus total premium) * number of contracts * 100 = €1,942 per 1 contract

  • Time value: out-of-the-money puts = all time value = €58 = premium received

  • You're ahead of an ordinary if the share price doesn't rise above €20.54 + €0.58 = €21.12, this is important to determine how bullish you are

  • If the share price closes below €20 at expiration, your adjusted cost basis is €19.42 = breakeven; if the shares close above the strike price; you'll never get assigned!

  • If Fagron goes up, we don't generate additional profits, but we can close out the trade earlier than anticipated and sell a different cash-secured put.

The €21 put

The following bullet points tell you everything you need to know about this out-of-the-money put:

  • Downside protection of the profit: NONE! (this applies only to out-of-the-money puts)

  • Breakeven: €19.96 (strike price minus total premium)

  • Amount of cash required that you have to set on the sidelines to meet a possible future stock transaction: (strike price minus total premium) * number of contracts * 100 = €1,996 per 1 contract

  • Time value: in-the-money puts = premium - difference between strike price and current market value = €58

  • Loss on the stock side: €46 per contract = intrinsic value; so we get compensated for the loss we are expected to occur based on the price when writing the option (€20.54).

  • Upside potential: €46 per contract or the amount of intrinsic value

  • You're ahead of an ordinary if the share price doesn't rise above €20.54 + €1.04 = €21.58, this is important to determine how bullish you are. Selling an in-the-money strike is more bullish, because we can fully capture the intrinsic value if the price closes above the strike price.

  • If the share price closes below €21 at expiration, your adjusted cost basis is €19.96 = breakeven; if the shares close above the strike price, you will never get assigned!

  • If Fagron goes up to €21, we keep the entire premium which at the time of selling the option wasn't taken into consideration. We were supposed to generate time value only.


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