Selling cash secured puts on stocks an investor is happy to take ownership of is a great way to generate some extra income. A cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock. The goal is to either have the put expire worthless and keep the premium, or to be assigned and acquire the stock below the current price. It’s important that anyone selling puts understands that they may be assigned 100 shares at the strike price.
Why Trade Cash Secured Puts?
Selling cash secured puts is a bullish trade but slightly less bullish than outright stock ownership. If the investor was strongly bullish, they would prefer to look at strategies like a long call or a bull call spread. Investors would sell a put on a stock they think will stay flat, rise slightly, or at worst not drop too much.
Cash secured put sellers set aside enough capital to purchase the shares and are happy to take ownership of the stock if called upon to do so by the put buyer. Naked put sellers, on the other hand, have no intention of taking ownership of the stock and are purely looking to generate premium from option selling strategies.
The more bullish the cash secure put investor is, the closer they should sell the put to the current stock price. This will generate the most amount of premium and also increase the chances of the put being assigned. Selling deep-out-of-the-money puts generates the smallest amount of premium and is less likely to see the put assigned.
KMB Cash Secure Put Example
Kimberly-Clark (KMB) is an old school defensive stock with a 3.94% dividend yield.
Yesterday, with KMB trading at $120.79, the January put option with a strike price of $120 was trading around $3.10. Traders selling this put would receive $310 in option premium. In return for receiving this premium, they have an obligation to buy 100 shares of KMB for $120. By January 19, if KMB is trading for $110, or $100, or even $50, the put seller still has to buy 100 shares at $120.
But, if KMB is trading above $120, the put option expires worthless, and the trader keeps the $310 option premium. The net capital at risk is equal to the strike price of $120, less the $3.10 in option premium. So, if assigned, the net cost basis will be $116.90. That’s not bad for a stock currently trading at $120.79. That’s a 3.22% discount from the price it was trading yesterday.
If KMB stays above $120, the return on capital is:
$310 / $11,690 = 2.65% in 73 days, which works out to 13.25% annualized.
Either the put seller achieves an 13.25% annualized return, or gets to buy a high yielding stock for a 3.22% discount. You can find other ideas like this using the Naked Put Screener. Below you can see some parameters that you might consider for running this screener. Feel free to tweak them as you see fit.
Company Details
The Barchart Technical Opinion rating is an 88% Sell with an Average short term outlook on maintaining the current direction. Long term indicators fully support a continuation of the trend.
Of the 14 analysts covering KMB, 1 has a Strong Buy rating, 11 have a Hold rating and 2 have a Strong Sell rating.
Kimberly-Clark Corporation is principally engaged in the manufacture and marketing of a wide range of consumer products around the world. The company sells its products to supermarkets; mass merchandisers; drugstores; warehouse clubs; variety and department stores; retail outlets; manufacturing, lodging, office building, food service, and health care establishments; and high volume public facilities. Based on product grouping, the company conducts its operations in three business segments namely Personal Care, Consumer Tissue, and K-C Professional. The Personal Care segment includes products like disposable diapers, training and youth pants, swimpants, baby wipes, feminine and incontinence care products, and other related products. Products in this segment are sold under the Huggies, Pull-Ups, Little Swimmers, GoodNites, DryNites, Kotex, U by Kotex, Intimus, Depend, Plenitud, Poise and other brand names.
Summary
While this type of strategy requires a lot of capital, it is a great way to generate an income from stocks you want to own. If you end up being assigned, you can sit back and collect the healthy 3.94% dividend on offer from KMB. You can do this on other stocks as well, but remember to start small until you understand a bit more about how this all works.
Risk averse traders might consider buying an out-of-the-money put to protect the downside.
If you have any questions, feel free to reach out to me by email or on Twitter. Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
