Cash Secured Puts

Question - Writing Cash Secured Puts

What are the best stocks for writing cash secured puts when you don't want to own the stock?


There are actually two answers to that question - the objective answer and the subjective answer.

But just to make sure everyone is on the same page, here's a quick review: when you write or sell a put, you're giving someone else the right to sell you 100 shares of a certain stock (the underlying) at a certain price (the strike price) by a certain date (the expiration date) in exchange for a current cash payment.

If the stock closes at or above the strike price at expiration, the option expires worthless and you're off the hook. If, however, the stock is trading below the strike price at expiration, you will be obligated to purchase those shares at the agreed upon price.

And a cash secured put is simply a put where you have enough cash in your brokerage account to fully fund the purchase of the shares should the put be exercised and you get assigned.

Writing puts, when used strategically, such as in conjunction with a comprehensive Leveraged Investing option trading strategies approach, can be a great way to acquire shares of a quality company at a significant discount. But what if you really don't want to own the stock?

Objectively, the best stocks for writing puts against would share certain criteria:

  • Stocks with healthy levels of premium - Don't be seduced by extremely high levels of premium, which imply that the market is expecting lots of volatility on the stock. But you still want to receive enough income to justify your risk.
  • Stocks in a strong uptrend - Identifying these kind of stocks sounds easier than it actually is. But the ideal cash secured or naked put situation is where the stock moves higher immediately after you've set up the trade.
  • Stocks with solid fundamentals - No matter how careful you are, sometimes a trade will go against you. In this case, that means you'll be assigned and end up having to own the shares. At that point, your best defense is the protection that comes from owning shares in a solid and profitable business. The price dip that resulted in the assignment is more likely to be a temporary dip with a high quality company than it is with a low quality company where the price dip might prove to be permanent.

Just to be thorough, I should point out that if you want to avoid being assigned when your short put position is in the money (i.e. when the stock trades below the strike price), you can always close the postion early.

Presumably, this would be for a loss, although that would depend on how much below the strike price the shares are trading, how much time remains before expiration, and how much premium you received when you initially wrote the put.

Or you could also try adjusting the trade, rolling it out to a later expiration month for a smaller amount of premium as you wait/hope for the underlying stock to trade back above the strike price.

Subjectively, however, I would urge you to avoid this trade altogether. Or more specifically, I would urge you to avoid the rationale behind this trade.

Writing cash secured puts on stocks you don't want to own is an extremely schizophrenic approach. When you write a put you're offering to purchase a stock. Why would you offer to purchase something if you don't really want it? You're sending yourself a huge mixed signal.

Writing cash-secured puts should be reserved for those situations where yes, in fact, you really do want to own the stock. And if it's income you want, and if you're patient and creative, there are much smarter and safer ways to get it.

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Warren Buffett Zero Cost Basis Portfolio Current Equity Holdings:

KO - 125 shares
BP - 100 shares
MCD - 30 shares
JNJ - 25 shares
GIS - 25 shares
PAYX - 25 shares

Open Market Purchase Price: $16,066.88

Less Booked Option Income: $10,568.35

Tot. Discount: 65.78%
Adj. Div. Yield: 12.08%