# Downside to selling cash-secured puts?



## Dmoney (Apr 28, 2011)

I am considering selling cash-secured puts as opposed to putting in limit orders on stocks I am going to purchase anyway and was looking for any input from someone who may be employing a similar strategy or have experience with options trading.

Is there any significant downside to this strategy that is not present with outright ownership of the underlying?

I would most likely be looking to sell at the money puts in hopes of getting the stock at a discount (value of option premium) and would continue to do so until the options were exercised. 

Any input is appreciated.


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## andrewf (Mar 1, 2010)

You're not participating in the upside, but neither do you with limit orders. It's not a bad strategy at all. Depending on how badly you want to get into the stock, you can sell options well in the money (and pick up some of the upside in the price).


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## Lephturn (Aug 31, 2009)

The risks are basically the same as using limit orders. The benefit is that even if you don't get the stock put to you, you get paid to wait.

The only real negative is that they won't let you do it in a registered account.


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## HaroldCrump (Jun 10, 2009)

I've never done this but I suppose with relatively stable stocks, it's a good strategy to buy during dips.

But I see two possible drawback:

- Acquiring the underlying stock depends on being putted by the broker.
So the action is a little out of your control and you are at someone else's mercy.

- Between the time you sell the put option and the maturity date, if for some reason the stock begins to fall substantially, you will be catching a falling knife.
You may easily get putted well below the strike price.

Say RIM's current price is $53 and you sell a June $40 put.
If the stk falls substantially, you may get putted not at $40 but at $30.

It's possible by this time you've lost all interest in the stk and will have to pay a premium to close out your short put position.


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## Dmoney (Apr 28, 2011)

The limit on upside potential is the obvious cost of both selling a put or selling covered calls (both of which I am giving consideration). Like you suggested, selling in the money lets me get in on some upside price movement while still getting assigned the underlying, although it does reduce the slight downside protection and premium earned in sideways markets. 

The strategy I was hoping to employ would entail selling puts either one or two months out that will maximize value based on very little price movement. Obviously the goal is to get assigned the underlying at a discount, but assuming decent premiums, I would continue to sell monthly until I get assigned.


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## humble_pie (Jun 7, 2009)

i do sell a limited number of puts, but for income & not as a prelude to acquiring the stock.

as you know, the return on long stock less short call = short put plus interest on standby cash.

however, the way i see it, exercise of a put option & subsequent forcing of its stock has psychological effects that are uncomfortable for me.

if i were to do my homework, select & buy a stock, and it were subsequently to drop by 25% in the context of a severe down market, i would still be reasonably happy. For example, i might buy a stock at 20, sell its call option for 2, and still be content if the stock dropped to 15.

on the other hand, if i had sold a 20 put, and stock dropped to 15 in a severely downward correcting market, and stock was then assigned to me at 20, i would be extremely unhappy, even if i had received 2 for selling the put.

i know, it's not logical, it's just a state of mind. It's enough to keep my puts limited & fairly far out of the money. My tiniest put position in terms of number of contracts is goog. For years i've been selling one single goog put. My lonesome goog is good for at least one grand, sometimes 2, every 12 months.


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## atrp2biz (Sep 22, 2010)

For retail investors, a covered call would be better than an uncovered put.

The two strategies are exactly the same from a put-call parity stand point, but as a retail investor, one's interest expense is greater than one's interest income potential. Therefore, if you have the cash, you would be better off using the cash to acquire the underlying and selling the call than applying the cash at a very low interest income rate when selling a put.


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## Dmoney (Apr 28, 2011)

HaroldCrump said:


> - Acquiring the underlying stock depends on being putted by the broker.
> So the action is a little out of your control and you are at someone else's mercy.


I could be wrong, but I was under the impression that in the event that an option expires in the money, with the exception of index options, it is automatically assigned by the broker. Again, as far as I know this is Questrade's policy, but it is a valid point. If it is not automatically assigned do you know if it is simply cash settled?




HaroldCrump said:


> - Between the time you sell the put option and the maturity date, if for some reason the stock begins to fall substantially, you will be catching a falling knife.
> You may easily get putted well below the strike price.
> 
> Say RIM's current price is $53 and you sell a June $40 put.
> ...


Agreed, and this would be my major concern, that if I was out of favour with the stock I'd have to pay a significant premium to buy back the put I sold, based on the fact that sentiment must have shifted to precipitate such a turnaround in the stock price. Although I wouldn't be worried about the price drop (since it would be the same for outright ownership) I would be concerned that closing my position would cost significantly more.


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## atrp2biz (Sep 22, 2010)

Put-call parity is also what causes (for non-dividend paying underlyings) at-the-money calls to be valued slightly higher than the corresponding puts.

However, for dividend paying underlyings, if expiration is after ex-dividend, the puts would be valued higher than the calls. Depending on one's marginal rate (e.g. income < $83K), it may be beneficial to receive dividend income (in lieu of capital gains), thus making the covered call proposition even more attractive.

EDIT: Although comparison may be more complex for foreign, non-registered dividend paying equities.


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## Dmoney (Apr 28, 2011)

atrp2biz said:


> For retail investors, a covered call would be better than an uncovered put.
> 
> The two strategies are exactly the same from a put-call parity stand point, but as a retail investor, one's interest expense is greater than one's interest income potential. Therefore, if you have the cash, you would be better off using the cash to acquire the underlying and selling the call than applying the cash at a very low interest income rate when selling a put.


Would it not be neutral in the case of a cash secured put vs. covered call? If I'm not using margin to purchase the underlying in the case of a covered call, then interest rate doesn't come into the equation as far as I can tell. Also, since I earn nothing on cash balances, once more there is no difference between put and call in terms of interest income/expense. (Is there?)

I was under the impression however that in the case of a naked put sale, because I'm not using as much margin in comparison to a covered call, it would actually be better to use the naked put strategy.

Again, I could be wrong on both counts, but that was my initial perception.


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## atrp2biz (Sep 22, 2010)

I've been asked to elaborate. Here is an example of my reasoning. This assumes that you are considering a cash-secured put and that the cash would be simply sitting in your account earning little to no interest. The example also ignores transaction costs.









Attached are the quotes of YHOO and ATM calls and puts for June expiration (I was looking for any underling that was ATM to one of its options). The example assumes 100 shares and one option contract. The mid-point of the calls is $0.93 and the mid-point of the puts is $0.915.

*Covered Call:*
Initial debit = -100($18.00) + 100(0.93) = -$1,707

If YHOO >18 at expiration, credit = $1,800
_profit = $93_

If YHOO < 18 at expiration, credit = 100X, where X = stock price
_profit = 100X - 1,707_


*Naked Put:*
Initial credit = 100(0.905) = $90.50
If YHOO >18 at expiration, _profit = $90.50_

If YHOO < 18 at expiration, debit = -100($18.00) = -$1800, credit (to close position) = 100X, net debit = 100X - 1,800
profit = 100X - 1,800 + 90.50 _= 100X - 1,709.50_

In these instances, the CC is always better. However, if you have to borrow money to initiate a CC, the reverse would be true and it would be better to enter into the naked put. Again, this is because a retail investor must borrow at a rate above the interest rate implied by option pricing models and a retail investor yields interest income at a rate below the interest rate implied by the same models.


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## Causalien (Apr 4, 2009)

This is only worth while on stocks that have high volatility of 0.7 and above which present a large enough premium. Even with those advantages, I employ several other TA tests to ensure that I am not getting screwed short term.


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## Dmoney (Apr 28, 2011)

atrp2biz said:


> I've been asked to elaborate. Here is an example of my reasoning. This assumes that you are considering a cash-secured put and that the cash would be simply sitting in your account earning little to no interest. The example also ignores transaction costs.


Great, thanks a lot for the elaboration. I am leaning towards the covered call strategy, due to the lack of gains from holding cash in account, and because several companies I'm looking to use in the strategy pay dividends, and that should enhance returns further. 

I guess the big benefit to the naked put on margin is the lower margin requirements which lead to higher ROI, and only pay interest if the option is assigned.


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## humble_pie (Jun 7, 2009)

_" I guess the big benefit to the naked put on margin is the lower margin requirements which lead to higher ROI, and only pay interest if the option is assigned."_

but how could an account pay interest following a naked put assignment. Surely the reverse would obtain; that is, the broker would charge interest on the debt following assignment of stk to the investor unless inv had the cash available to pay for the stock.

i also think an example showing put/call parity for june options does look tickety-boo in a textbook sense but doesn't deal with the real life situation that could arise if stk falls severely during brief 7-week life of either the call or the put. 

i myself have some canadian long-term-holds-w-dividends-plus-short-strangles that i've held for many years. From time to time these require gymnastics to prevent assignment but in the end i'm rarely assigned.

stocks that don't pay dividends are more attractive candidates for naked put selling imho.


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## Dmoney (Apr 28, 2011)

humble_pie said:


> _" I guess the big benefit to the naked put on margin is the lower margin requirements which lead to higher ROI, and only pay interest if the option is assigned."_
> 
> but how could an account pay interest following a naked put assignment. Surely the reverse would obtain; that is, the broker would charge interest on the debt following assignment of stk to the investor unless inv had the cash available to pay for the stock.


That's what I had intended to say... There is no opportunity cost with a naked short on margin because you are not leaving money idle in cash. Also, interest is only _charged_ when it is assigned. Poor sentence structure on my part.

The attraction of the naked put is the ROI which can be had due to the relatively small margin required.

Based on the Yahoo! example at $18 even the required margin would be as follows:

Position
Short 1 May 18 puts(s) at $0.90
Underlying stock at $18.00
Put is at-the-money

Initial Margin
Margin requirement: $450.00
Proceeds from sale of short put(s): $90.00
Margin call (SMA debit): $360.00

$90/$450 = 0.2

In theory a 20% return for a one month position.


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## atrp2biz (Sep 22, 2010)

Dmoney said:


> Great, thanks a lot for the elaboration. I am leaning towards the covered call strategy, due to the lack of gains from holding cash in account, and because several companies I'm looking to use in the strategy pay dividends, and that should enhance returns further.


Remember that this would be priced into the options as well. If the option expires after the ex-dividend date, an ATM call would be worth less than an ATM put (based on the PV of the lost opportunity of collecting the dividend payment).


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## atrp2biz (Sep 22, 2010)

Causalien said:


> This is only worth while on stocks that have high volatility of 0.7 and above which present a large enough premium. Even with those advantages, I employ several other TA tests to ensure that I am not getting screwed short term.


You get what you pay for (and vice versa). For most stocks, selling options with IVs greater than 70% means selling into earnings or other event risks.

To me, since options are a zero sum game universe, CCs and NPs can be used to reduce the beta of a stock portfolio, while having no effect on alpha in the long-term, thus increasing the Sharpe ratio of a portfolio.


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## londoncalling (Sep 17, 2011)

I am resurrecting this thread as I have always been fascinated with selling puts in a declining market. If i want to buy ABC at $10 but it is currently at $12 what is the problem in selling a put at $10 and collecting the premium until expiry or it is excercised. I know Derek Foster built a large portfolio using this strategy. I am trying to figure out the downside. Obviously, the premium needs to be worth the cost of contract and the opportunity cost of having funds typed up. I am not sure if there are poster still here that have utilized this strategy in a down market. I would be looking at some high volume, large cap names if I decide to implement this strat. I also would only do this with US or interlisted names as the Canadian exchanges really don't have large enough volume to prevent getting steamrolled by market makers. Many of the posters on this decade old thread are no longer active but I believe the information is still relevant. I have reread the threads on options here but would be interested in listening to some podcasts if anybody follows any.

Of course I would have to do this in a non registered account.


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## Covariance (Oct 20, 2020)

londoncalling said:


> I am resurrecting this thread as I have always been fascinated with selling puts in a declining market. If i want to buy ABC at $10 but it is currently at $12 what is the problem in selling a put at $10 and collecting the premium until expiry or it is excercised. I know Derek Foster built a large portfolio using this strategy. I am trying to figure out the downside. Obviously, the premium needs to be worth the cost of contract and the opportunity cost of having funds typed up. I am not sure if there are poster still here that have utilized this strategy in a down market. I would be looking at some high volume, large cap names if I decide to implement this strat. I also would only do this with US or interlisted names as the Canadian exchanges really don't have large enough volume to prevent getting steamrolled by market makers. Many of the posters on this decade old thread are no longer active but I believe the information is still relevant. I have reread the threads on options here but would be interested in listening to some podcasts if anybody follows any.
> 
> Of course I would have to do this in a non registered account.


I write puts to accumulate positions. Downside in general: You may still pay more than you would have by being patient and timing a straight forward purchase of shares on a down day. Next, there Is the investment in time to do with any real success. It takes judgment, knowledge to determine exercise price, expiration date that set you up to profit and reduce risk. Lots can happen between the date you write and expiration. Planning for known unknowns in the calendar (Eg earnings releases, industy news releases, macro events) helps to limit the surprises.


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## KaeJS (Sep 28, 2010)

londoncalling said:


> I am resurrecting this thread as I have always been fascinated with selling puts in a declining market. If i want to buy ABC at $10 but it is currently at $12 what is the problem in selling a put at $10 and collecting the premium until expiry or it is excercised. I know Derek Foster built a large portfolio using this strategy. I am trying to figure out the downside. Obviously, the premium needs to be worth the cost of contract and the opportunity cost of having funds typed up. I am not sure if there are poster still here that have utilized this strategy in a down market. I would be looking at some high volume, large cap names if I decide to implement this strat. I also would only do this with US or interlisted names as the Canadian exchanges really don't have large enough volume to prevent getting steamrolled by market makers. Many of the posters on this decade old thread are no longer active but I believe the information is still relevant. I have reread the threads on options here but would be interested in listening to some podcasts if anybody follows any.
> 
> Of course I would have to do this in a non registered account.


It's a great strategy, so long as you are 100% okay paying the price for the stock if it falls below your strike.

It can take some guts in a declining market, but if you stick with it, it can definitely be very profitable.

Usually people get themselves into trouble because they start to overleverage themselves and start selling puts to generate premium without having the capital to back it up when things go sour.

If you have the capital and don't overleverage yourself, it's usually pretty hard to lose long term if you are selling the puts on stable companies.


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## m3s (Apr 3, 2010)

Retail buys 3x more puts than calls recently

Apparently retail options have never been so one sided in history

The volatility sure is lucrative


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## londoncalling (Sep 17, 2011)

KaeJS said:


> It's a great strategy, so long as you are 100% okay paying the price for the stock if it falls below your strike.
> 
> It can take some guts in a declining market, but if you stick with it, it can definitely be very profitable.


I figure instead of placing some lowball orders and letting them sit for weeks on end. May not get to it in 2022 as I want to ensure I have next year's TFSA and RRSP contributions covered first.


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