Cash Secured Put is one of the best trading strategies to apply when you are about to invest in a particular stock but think that at this point, the stock is slightly over-priced.
The main motive of this strategy is to benefit from the short-term potential down move and then to invest in that stock for long-term appreciation. While deploying this strategy, one has to keep in mind that you need to set aside enough cash in order to buy that stock in an equivalent proportion as compared to a standard fno lot.
So, In today’s lesson, let’s see how we can apply cash-secured put and how you can benefit from it.
Cash Secured Put is nothing but shorting out of the money put option and then covering it later by actual shares. Now let’s understand this with a practical example.
For example, let’s say you want to invest in Reliance, but by doing your own analysis at this point, you think that the stock is slightly overpriced, and you want Reliance to come down. At the same time, you don’t want to miss the stock’s upside potential.
So, in this scenario, we apply a cash-secured put option strategy. Consider the current price of the Reliance is Rs.2460. Now, In order to apply this strategy, let’s short-reliance 2400PE option.
Now, let’s consider different possibilities-
1) Suppose things go as per plan, and the stock dips all the way up to 2400. In that case, you will get all the premium, + you will also buy the shares of Reliance as a part of this strategy.
2) In another case, suppose Reliance goes up again, then in that case, you will get all the premium.
3) Let’s consider another case where the stock goes below your strike price, i.e. 2400, where you will book a loss on a short put (But that loss generally gets compensated in the long run). Also, in this case, you will get the share at a cheaper rate.
Now, One important thing to understand here is that one lot of Reliance contains 250 shares. Now, if you want to buy the Reliance at 2400, you need to buy the same quantity as it is in the FnO segment, which is 250. So, you should keep aside Rs.6,00,000 before deploying this strategy.
The maximum gain in this strategy will be the premium received from the shorting put option.
The maximum loss in this strategy will be a short-term loss as you will take the delivery of the stock. Also, the loss will be reduced by the premium received if stock expires below the shorted strike price.
Also, keep in mind that the maximum loss is much lower than what would have occurred by buying the stock earlier at a high rate previously instead of shorting the put option.
A sharp increase in Implied volatility will have a negative effect on this strategy as a high fear in the market can hike the prices of put options. Although, a moderate increase in implied volatility will put a neutral to a slightly negative effect on this strategy.
Time decay will positively affect this strategy as you want to take the entire premium of shorted put. If the stock expires above the strike price, then, in that case, the investor will keep the entire premium.
So this was a brief explanation of the cash-secured put option strategy. It is the best strategy we can use for the investment purpose where we sell an out-of-the-money put option. By doing this, we also lock limited upside potential, and we also plan to take the delivery of actual shares if the stock dips to a pre-determined level. The loss that occurred in this strategy will be short-term as it will be compensated when your stock investment will profit in the longer run.
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