Writing Cash Secured Puts
A put is a contract you can sell to generate income, OR to buy shares at a lower price. Specifically these contracts obligate you to buy 100 shares per contract at the stated strike price if shares trade below that level by the expiration date.
You can either write a naked put, or a cash secured put. Naked simply means that rather than setting aside enough money in your brokerage account to pay for the shares, you are using other assets, including shares of other companies, to cover the margin maintenance requirement.
This is a form of leverage that can easily get you in trouble should the stock move against you; potentially risking a margin call. That occurs if the value of your portfolio falls below a certain level, set by Federal regulations.
In the event of a margin call you either have to add more money to your account, or your broker will automatically sell your other holdings to come up with additional funds to meet the maintenance requirement.
In other words, this is a highly risky and speculative use of options that I advise all long-term dividend investors to avoid (see five other risks dividend investors should avoid here).
A cash secured put on the other hand, involves keeping the necessary money to buy the shares in your account and waiting to see whether the option will be triggered, or expire worthless; meaning the share price is above the strike price at expiration. In that case you keep the premium, which represents the income you generate from this strategy.
Writing Covered Calls
Calls are the opposite of puts, meaning rather than obligating you to sell shares at a certain strike price, they obligate you to sell 100 shares per contract at the strike price.
And like with puts you can write naked calls, meaning you don’t own the shares you might have to sell to the buyer of the call, or covered calls; meaning you own the shares and agree not to sell them before the expiration date.
Again, I highly advise only ever writing covered calls, as this avoids leverage, and ensures that you won’t ever receive a margin call, and forced liquidation. That’s when your broker automatically sells your holdings, at whatever the market price may be, to come up with enough capital to meet the maintenance requirement.
This kind of price incentive selling can result in selling at the exact wrong time (i.e. a market collapse), and result in large permanent capital losses.
Cash Secured Put Example: Pfizer Inc. (NYSE:PFE)
Say you believe that Pfizer is a great long-term dividend growth stock that is currently undervalued.
Because of this undervaluation the chances of Pfizer falling dramatically are lower, barring a strong, broad market correction. By selling puts you can buy shares at an even steeper discount, OR should shares stay at current levels or rise before expiration, you will generate potentially solid income.
The data below is as of October 6, 2016, when Pfizer traded at about $33.90 per share.
| Put Option | Premium / Share | Implied Buy Price | Discount To Current Price | Yield On Implied Buy Price | Premium Yield | Annualized Premium Yield |
| Nov 11 $33.5 | $1.23 | $32.27 | 3.8% | 3.7% | 3.8% | 47.7% |
| Nov 11 $32 | $0.38 | $31.62 | 5.8% | 3.8% | 1.2% | 13.2% |
| Mar 17 $33 | $1.52 | $31.48 | 6.2% | 3.8% | 4.8% | 11.3% |
| Mar 17 $29 | $0.55 | $28.45 | 15.1% | 4.2% | 1.9% | 4.4% |
Source: Yahoo Finance
