What are CSP (Cash Secured Puts)?
A cash-secured put is a strategy that involves writing (selling) a put option while simultaneously setting aside sufficient cash to cover the potential purchase of the underlying stock at the predetermined strike price. The process of executing a cash-secured put begins by selecting an at-the-money or out-of-the-money put option.
An "at-the-money" put has a strike price that is equal to or very close to the current market price of the underlying stock. On the other hand, an "out-of-the-money" put has a strike price below the current market price.
By selling the put option, the investor collects a premium, which is the payment received from the buyer of the option. This premium is the investor's immediate profit if the put option expires worthless. However, to ensure the ability to fulfill the obligation of purchasing the stock if the option is exercised, the investor sets aside enough cash in their account to cover the cost of buying the stock at the strike price. en an investor sells a put option, they receive a premium upfront. This premium is the income earned from selling the option and represents the potential profit. If the price of the underlying asset stays above the strike price until the option's expiration, the option will expire worthless, and the investor gets to keep the premium as their profit.
What is the objective when selling CSPs?
The primary objective of a cash-secured put strategy is twofold. First, the investor hopes for the put option to expire worthless, allowing them to keep the premium received as profit. This outcome is favorable when the price of the underlying stock remains above the strike price, making it unlikely for the option to be exercised by the buyer.
Alternatively, if the put option is assigned (exercised) by the buyer, the investor is obligated to buy the underlying stock at the strike price. In this scenario, having the cash set aside allows the investor to acquire the stock at a lower price than the prevailing market price. This potential benefit arises when the price of the underlying stock falls below the strike price, making the assignment attractive.
How many shares is one CSP option contract?
In the options market, a standard contract typically represents 100 shares of the underlying asset. Therefore, if you sell a single cash-secured put option contract, it would generally be associated with 100 shares. If the option gets assigned you will own 100 shares for each CSP option contract sold.
What is the Break Even Point for CSP?
The break-even point for a cash-secured put is the price at which the investor's potential profit is zero. It represents the point at which the premium received from selling the put option offsets any potential losses that may be incurred if the option is exercised.
To calculate the break-even point for a cash-secured put, you subtract the premium received from the strike price of the put option. If the market price of the underlying asset falls below this break-even point, the investor will start to incur losses. However, if the market price remains above the break-even point, the investor will either earn the premium as profit or, if the option is not exercised, keep the premium as income.
What is the Maximum Potential Profit for CSP?
Potential profit is equal to the premium received from selling the put if the price of the underlying asset remains above the CSP strike price at the option expiration date. When an investor sells a put option, they receive a premium upfront. This premium is the income earned from selling the option and represents the potential profit. If the price of the underlying asset stays above the strike price until the option's expiration, the option will expire worthless, and the investor gets to keep the premium as their profit.
What's a Common Mistake People Make with CSPs?
A common mistake people make is selling naked puts using their broker's margin, which is always less than the actual cash required to buy the shares in case the option gets assigned. Selling CSPs on margin without actual cash reserves goes against the principle of selling CSPs. If the put option is exercised and you are assigned the shares, you may find yourself in a very unfavourable situation. Without sufficient cash to buy the underlying asset, you could face a margin call or be forced to liquidate other positions at unfavorable prices to fulfill your obligation. Such scenarios can result in significant losses and disrupt your overall investment strategy.