A cash-secured put offers a number benefits as an options strategy. It can be used to pick up shares of a stock at a lower price or generate income. It's an easy strategy to understand for beginners and has some similarities to the covered call strategy.
Investing Across The Pond
The iShares MSCI United Kingdom ETF started trading sideways last month with a trading range between 33.09 and 31.79. The ETF gets you diverse exposure to some well-known names like Shell, AstraZeneca and Unilever. Income investors might also find the 3.2% yield on EWU attractive.
Investors wanting to take ownership of EWU can potentially do so at a reduced price with an options strategy known as a cash-secured put.
A cash-secured put is a slightly less bullish trade than buying a stock outright. It is considered a neutral to slightly bullish trade.
How To Set Up A Cash-Secured Put
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 at the strike price. The goal is to either have the put expire worthless and keep the premium or be assigned and acquire the stock below the current price.
Traders selling cash-secured puts need to understand that they may be assigned 100 shares at the strike price. The cash set aside prepares you for that possibility.
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Let's look at an example using EWU.
With the stock trading at 32.62 yesterday, the July 21 put with a strike price of 32 sold for around 1.25 per contract.
An investor selling this put receives $125 into their account, which is theirs to keep. They also take on the obligation to buy 100 shares of EWU if it falls below 32 by July 21.
Their buy price, no matter how far down it goes, is 32. But the effective net cost of the position would be 30.75, thanks to the option premium received. That is 5.8% below yesterday's closing price and below the current trading range on EWU. Not a bad discount.
If the ETF stays above 32 at expiry, the put expires worthless. That's not a bad outcome either. The option trader keeps the full premium received and gets an extra 4.1% return on capital at risk. That works out to 10.3% annualized.
Risks Of The Trade
The main risk with the trade is similar to owning the ETF itself, but slightly less. If the ETF falls quickly, the trade will suffer a loss. However, the premium received helps to offset the loss.
The maximum loss on the trade would occur in the highly unlikely case that EWU fell to $0, which would see the trade lose $3,075, but most traders would cut losses long before then.
Cash-secured puts are a great way to generate a return on strong stocks and ETFs, potentially without ever having to take ownership.
If the put does get assigned, the investor takes ownership with a reduced cost base and can potentially begin selling covered calls to generate additional income from the position.
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.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
