NOTE: This graph shows profit and loss of long stock and the short put.
Selling the put obligates you to buy stock at strike price A if the option is assigned.
In this instance, you’re selling the put with the intention of buying the stock after the put is assigned. When running this strategy, you may wish to consider selling the put slightly out-of-the-money. If you do so, you’re hoping that the stock will make a bearish move, dip below the strike price, and stay there. That way the put will be assigned and you’ll end up owning the stock. Naturally, you’ll want the stock to rise in the long-term.
The premium received for the put you sell will lower the cost basis on the stock you want to buy. If the stock doesn’t make a bearish move by expiration, you still keep the premium for selling the put. That’s sort of nice, because it’s one of the few instances when you can profit by being wrong.
Who Should Run It
Rookies and higher
NOTE: Cash-secured puts can be executed by investors at any level. The Rookie’s Corner suggests other plays more suited to beginning options traders.
When to Run It
You’re slightly bearish short-term, bullish long-term.
Break-even at Expiration
Strike A minus the premium received for the put.
The Sweet Spot
You want the stock price to be just below strike A at expiration. Remember, the goal here is to wind up owning the stock.
Maximum Potential Profit
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.)
Maximum Potential Loss
Potential loss 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.)
TradeKing Margin Requirement
You must have enough cash to cover the cost of purchasing the stock at the strike price.
NOTE: The premium received from establishing the short put may be applied to the initial margin requirement.
As Time Goes By
For this strategy, time decay is your friend. You want the price of the option you sold to approach zero. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back.
After the strategy is established, you want implied volatility to decrease. That will decrease the price of the option you sold, so if you choose to close your position prior to expiration it will be less expensive to do so.
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