How ‘Cash Secured Puts’ Can Provide Investors With Downside Price Protection 

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During his recent interview with Tobias. Tim Travis of T&T Capital Management discusses how ‘cash secured puts’ provide investors with downside price protection, saying:

Tim Travis: Yeah. So, a cash secured put just means you’re not necessarily exploiting the margin factor. So, if we’re selling just a stock, let’s say stock’s at $55 per share, and we’re selling a $50 put expiring in a year from now. And let’s say we’re collecting $500 of premium. Basically what we’re saying is, if this stock, which is at $55, expires above $50, we keep $500 premium on $4,500 of maximum risk, 100 shares times the break even price.

Our worst case scenario is that we end up owning that stock at $45, which is the break even price. So, we look at it as a kind of a heads we win, we get the income, $500 over $4,500, nice double digit return with junk bonds yielding 6% right now, or whatever it is. I mean, right around there. That’s a heck of a return. You’ll have a little more volatility with options.

Worst case scenario, we ended up owning a stock we want to own anyways. Let’s say it’s worth $80 in our estimation. We own it at $45. So, that’s cash secured. You’re just saying, you’re allotting for the full $4,500 of potential exposure in your account. Some people will blow themselves up with a margin. So, sorry, I didn’t mean to interrupt you there, but yeah.

Tobias Carlisle: I just want the listeners to understand that the risk profile of a selling a put looks like the equity down side. So, your downside tracks. It’s like buying a share, and if it goes to zero you go to zero as well. But because, and this is where you were just about to go I think when you … Because you can put so much more of your portfolio into the premium, you can sell many, many times your portfolio value. And so, if that in fact happens, you can be wiped out. So, I think that’s what you were just about to say.

Tim Travis: Yeah. That’s what you want to avoid. Because I mean, when people really realize that the power of selling put, I mean it’s very sensible. Most people when I can outline the strategy, if they’re not akin to it,, they’ll say, “Why doesn’t everyone do this?” And there’s a lot of reasons. A lot of people can’t really value a company firstly. Secondly, a lot of people aren’t really wanting to own a stock. They’re not like that. They just think, hey, I want my options to expire worthless, or I’ll take my losses. That sort of thing. More of a trading mentality. So, you’re exactly right. So, cash secured is the important thing. I don’t want anyone to blow themselves up with we’re not advocating that.

Tobias Carlisle: So, if you have a portfolio and you might put 10% of the portfolio into any given … Say you want to put 10% of the portfolio into AGO. I’m not necessarily recommending that, I’m just saying, for example. If you wanted to put 10% into AGO, and then you go and look at the options. So, the actual option premium that you might get might be 1% or something like that of your entire portfolio value. But that could still be putting 10%. That’s like having a 10% position on, that’s a notional 10%.

Tim Travis: Yes, yes. That’s why you always want to look at kind of your max exposure on it. What’s your full put exposure and look at it that way is the important way to do it for sure.

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5 Comments on “How ‘Cash Secured Puts’ Can Provide Investors With Downside Price Protection ”

  1. It seems that cash secured puts protect you against the upside risk better than the downside risk. If the 55 dollar stock that is “worth $80 in our estimation” actually goes to 75 rather than 80, you still only gain the 500 from your put sale, rather than the 2000 you would have gained from buying the stock. If it drops to 35, you lose 1000 rather than the 2000 you would have lost if you had bought it outright.

    So you lose less than buying the stock, but you your potential upside is capped at 500 while your downside is only capped at a loss of 4500.

  2. I do not understand how the worst case scenario is owning a stock at 45 in this example. If the put is exercised with the stock at 0 you loose 4500. Is not this the worst case scenario? And you have no opportunity to get out of the deal when you see the stock go down.

  3. I think I understand the original statement now: You own the stock as if you would have bought it at 45.
    Or even more precise: You own the stock at the moment the option is exercised as if you would have bought the stock at 45.

    What I do not like about selling options is that you give somebody “options” but get back “obligations”. Having options reduces risk. Having obligations enhances risk.

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