What I want to talk about right now is the difference between cash secured vs naked puts.
If you have been following Сoffee with Markus, then you know that recently there was a comment from someone who said:
“They are the same thing!”
Of course, that is not the case.
So in this article, I’ll show you the differences between cash secured vs naked puts.
I’ll also explain why I highly recommend that you trade cash secured puts when trading the Wheel strategy.
If you’d like to see the strategy in detail you can watch this video
Selling A Put Option
When you sell a put option it means that you have to buy the stock at the strike price that you sold it for if the contract is exercised at expiration. This is very important, and you are obligated to do it.
So, therefore, obviously what you want is that the stock stays above the strike price that you chose. Because in this case, you just keep the premium.
Now, let me give you a very, very specific example here.
Put Example: IBM
So recently, I sold a 115 put on IBM. I did this with three days to expiration and I received a premium of $43 per option that I traded.
Now, I traded two options, or two contracts. So this means that I received $86 in premium.
If you divide this by three days, this means that we are looking at approximately $29 per day in premium, which is what I’m looking for.
I mean, this is how I have achieved the very systematic results here of 22.7% over the last three months, and if I can keep this up, this would translate into 19.8% per year.
So thus far, what does it have to do with cash secured or naked puts here?
In this example, as long as IBM stays above 115 until expiration, I would just keep the $86 in premium and the option expires worthless.
However, if IBM would close below 115 at expiration, then I have to buy 100 shares of IBM at a price of $115.
So in my case, since I have sold two options, I would have to buy 200 shares of IBM at $115. This means that I would have to bring $23,000 to the table.
But here’s the deal. In order to sell these puts, my broker only required around $4,400. Let’s take a look at this.
See IBM here, it says capital required $4,453. That’s only 20% of the money that I actually need to buy the shares.
The Differences Between Cash Secured vs Naked Puts
Now let’s talk about the difference between cash-secured puts and naked puts.
Cash secured puts mean that you have $23,000 in your account to cover the stocks if you are getting assigned.
So if you only had $5,000 in your account, you could still place the trade. As you can see, the broker only required $4,453.
However, you wouldn’t have enough money to actually buy the shares if you got assigned.
This means that you sold the naked puts. You just don’t have enough money. You just had enough money for the broker, what he required to sell it.
So why would the broker let me sell the puts for only $4,400 when I need $23,000 to buy the shares if I get assigned?
Well, here is why the broker does it. He does it for two reasons.
Reason number one, most options expire worthless.
And number two, even if they don’t expire worthless most traders buy the option back. So they close it before they expire and the broker knows that.
That’s why he’s only requesting 1/5 of the buying power that you need for buying the shares. And that’s all good as long as you close your position before expiration.
However, when trading the Wheel, you actually want to get assigned. It is part of the strategy.
You see, we not only sell a put option, if we get assigned we will sell calls and get the premium.
Again, if you would like to have more information on the strategy you can watch this video
So the question now is…
What Happens If You Don’t Have Enough Money And You Get Assigned?
Let’s say you have $5,000 in your account and you entered this trade.
Now IBM is below 115 at expiration and you have to buy 200 shares at $115, but you don’t have the money.
So what happens?
Well, now your broker is buying them for you and you get a so-called ‘margin call’.
What does it mean?
A margin call basically means the broker asks you to wire the remaining $19,000 that you need for this into the account, and he wants to have this pretty much that day.
What happens if you don’t have the money?
If you don’t do this, the broker will sell the shares the next day at whatever price he can get.
So this means that you lose all control over this trade. Your broker is now in control and that’s not good.
You see, when trading the Wheel strategy you want to remain in control. After we get assigned the shares, we want to sell calls against it and collect even more premium.
I highly recommend that you trade cash secured puts so that you have enough money in the account in case you get assigned.
This way, you have full control over your shares and you can actually make money with them.
Now you know the difference between cash-secured puts vs naked puts and you know when to use what.
Was this helpful? If so, leave a comment below and feel free to share this article.
Read Next: Does Trading Really Work?
Good explanation. I enjoy your videos.
Thank you for your kind comment, Jean! 🙂
So the broker sells the stock after margin call, so i can loose more then my 5000$ ?
Anything is possible: If the stock plunges on Monday morning, theoretically yes. But most of the time, stocks open within 1-3% of their close on Friday, so the loss won’t be very dramatic. But you lose all control, and that’s not good.