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.
MRK Cash Secure Put Example
Yesterday, with Merck (MRK) trading at $103.94, the November put option with a strike price of $100 was trading around $1.78. Traders selling this put would receive $178 in option premium. In return for receiving this premium, they have an obligation to buy 100 shares of MRK for $100. By November 17, if MRK is trading for $99, or $90, or even $60, the put seller still has to buy 100 shares at $100.
But, if MRK is trading above $100, the put option expires worthless, and the trader keeps the $178 option premium. The net capital at risk is equal to the strike price of $100, less the $1.78 in option premium. So, if assigned, the net cost basis will be $98.22. That’s a 5.41% discount from the price it was trading yesterday.
If MRK stays above $100, the return on capital is:
$178 / $9,822 = 1.81% in 50 days, which works out to 12.97% annualized.
Either the put seller achieves an 12.97% annualized return or gets to buy a high yielding stock for a 5.41% 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 a strongest short term outlook on maintaining the current direction.
Of 17 analysts covering MRK, 13 have a Strong Buy rating and 4 have a Hold rating.
Implied volatility is currently 23.48% compared to a 12-month high of 28.16% and a low of 17.43%. The IV Percentile is 82% and the IV Rank is 51.60%.
Merck & Co. boasts more than six blockbuster drugs in its portfolio with PD-L1 inhibitor, Keytruda, approved for several types of cancer.
Keytruda has played an instrumental role in driving Merck's steady revenue growth in the past few years.
Well-known products in Merck's portfolio include Keytruda, Simponi , Januvia and Janumet, Bridion, Isentress, ProQuad, Gardasil, Pneumovax 23, RotaTeq and Belsomra.
Merck made its biggest acquisition of Schering-Plough and sold off its Consumer Care business to Bayer.
Other key acquisitions include Idenix Pharmaceuticals, Cubist Pharmaceuticals, Rigontec, ArQule and Acceleron Pharma. IMerck spun off products from its Women's Health unit, legacy drugs and biosimilar products into a new publicly traded company called Organon & Co.
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 2.77% dividend on offer from MRK. 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.
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.
