Basic Options Strategies: Cash Secured Put - Part Two
...Continued From Part One
Risk vs. Reward
Maximum Profit: Limited to Premium Received
Maximum Loss: Substantial (Strike Amount - Premium Received)
Upside Profit at Expiration: Premium Received from Put Sale
Net Stock Purchase Price if Assigned: Strike Price - Premium Received from Put Sale
If the underlying stock increases in price and the put expires with novalue, the profit is limited to the premium received from the put’sinitial sale. On the other hand, an outright purchase of underlyingstock would offer the investor unlimited upside profit potential.
Ifthe underlying stock declines below the strike price of the put, theinvestor might be assigned an exercise notice and be obligated topurchase an equivalent number of shares. The net stock purchase pricewould be the put’s strike price less the premium received from theput’s sale. This price can be less than current market price for thestock when assignment is made.
The loss potential for this strategy is similar to owning an equivalentnumber of underlying shares. Theoretically, the stock price can declineto zero. If assignment results in the purchase of stock at a net pricegreater than the current market price, the investor would incur a loss- unrealized as long as ownership of the shares is retained.
BEP: Strike Price - Premium Received from Sale of Put
If Volatility Increases: Negative Effect
If Volatility Decreases: Positive Effect
Note: Any effect of volatility on the option’s total premium is on the time value portion.
Passage of Time: Positive Effect
With the passage of time, the time value portion of the option’spremium generally decreases. This is a positive effect for an investor with ashort option position.
Alternatives Before Expiration?
If the investor’s opinion about the underlying stock changes before theput expires, the investor can buy back the same contract in themarketplace to "close out" his position,thereby realizing a gain orloss. After this is done, no assignment is possible. The investor isrelieved from any obligation to purchase underlying stock.
Alternatives At Expiration?
If the short option has any value when it expires, the investor willmost likely be assigned an exercise notice and be obligated to purchasean equivalent number of shares. If owning the underlying shares is notdesired, the investor can close out the written put by buying acontract with the same terms in the marketplace.
Such a purchase wouldhave to occur before the end of market hours on the option’s lasttrading day, and could result in a realized loss. On the other hand,the investor is obliged to take delivery of the underlying shares at apossible unrealized loss, in the event of assignment."
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