Covered Calls and Cash Secured Puts (Part 2)

A cash secured put (CSP) is a naked put (NP) covered by cash.  If I sell the Nov 495 AAPL put, for example, then I would need $495/share * 100 shares = $49,500 in the account for a CSP.

While covered calls (CC) and NPs are synthetically equivalent, one apparent difference is that the CC is more expensive.  In a margin account, a CC costs approximately 50% of the stock price whereas a NP costs approximately 20% of the stock price.  I say this is an “apparent” difference because in the worst case scenario, the NP trade would require me to pay the strike price for a worthless stock.  The total loss, then, would be the same loss incurred if the CC were traded:  strike price minus the credit received for the option sale.

Practically speaking, only under exceptional circumstances would a NP [or CC] result in total loss.  More commonly, the stock might lose value, which would force me to buy it (option assignment) for more than its current market price.  That could result in substantial loss but at least I have shares that I can turn around and immediately sell.  If I lose 10-20% of the stock’s purchase price or even 50% then that is still far less than total loss.

For this reason, some people suggest using NPs to establish “additional positions” in margin accounts.  Assuming I have cash available to buy 100 shares, these gurus say it’s okay for me to sell 2-3 NPs because even this would only cost me 40-60% of the stock price.  USE CAUTION, I say, because if the stock price falls sharply then you may be on the hook for more than you have.  Your trading days could be over!

In a retirement account, all NPs require at least as much cash in the account to purchase the stock at the strike price.  In other words, in a retirement account all NPs are CSPs.