Long Calls & Cash Secured Puts Option Strategies
With such a large scope of options trading strategies, it is easy to get lost in the complexity of it all. And it’s important to master some basic strategies before diving into the more complicated methods. In this article, we are going look at some of the basics by reviewing two of what I would call the bread and butter options strategies- long calls and cash secured puts.
What is a long call?
A long call gives you the right (not obligation) to buy a stock at a specified strike price on or before a future expiry date. It is a low-risk bullish strategy, with a profit potential that is infinite as there is no limit to how high a stock could rise. The potential of loss is limited to the premium/debit that was paid upfront for the option.
Say you buy a call option that is trading with a contract price of $2.25 per share. Since every option contract is worth 100 shares, there will be debit of $225 (100 x $2.25) from your account. So there’s your maximum loss already accounted for from the get go, now the only way is up!
In order to breakeven, the stock pice has to reach the point that equals the strike price + the premium that you paid. And in order to maximize profit, you need the stock price to rise significantly beyond that.
So let’s say the strike price is $100, and the stock is now trading at $105. You decide to exercise your option now, what does this give you? Well now you have the right to buy that stock at $100, and turn around and sell it for $105.00 per share! Minus the $2.25/share option premium you paid up front, you will make $2.75/share or $275.
That is a great profit!
And if you decide not to sell right away, ideally the stock price will continue to rise and you could sell the shares for an even larger profit!
Long calls are to be used when you believe that the stock price is going to go up way beyond the strike price. Otherwise, the time decay will prevent you from making any profit. The safety net is in the premium paid is the maximum loss from this strategy.
Cash secured puts
A cash secured put is when you sell a put option while at the same time putting aside the funds required to purchase the stock at the strike price in case of assignment. If the option expires OTM (out-of-the-money) and worthless, or even if it expires ITM and the stock is assigned, you get to keep the premium as income!
The main goal of this strategy is generating profit from the premium you collect when you sell the option. The maximum profit being the premium received minus any broker commissions/fees.
In this example, lets say you sell a cash secured put with a strike price of $80 with an option premium of $1/share. You would need to set aside $8000 for the potential share purchase in case it gets assigned, but you also receive $100 ($1 x 100 shares) premium from the buyer.
Now if the stock price stays above $80 at expiration, meaning the option expires worthless, you keep the premium as income. But if the stock price drops below $80 at time of expiry, the contract will be assigned and you will buy 100 shares at $80 per share. And and you still keep the Option premium.
You would use this strategy when you expect the stock be bullish and remain above the strike price. The worst case scenario is if the stock falls significantly before expiration, and you get assigned shares at a price that’s way above the current market price. However, this is only a problem if you need to sell the shares before the price recovers.
A slight fall below the strike price resulting in option assignment shouldn’t be a concern. This actually allows you the ability to do another income generating options strategy called the Covered Call. Together, the Cash-Secured Put and Covered Call make up the Wheel Strategy.
Let me know in the comments how these strategies have worked for you!