Investors who sell cash-secured puts generally are willing to buy the underlying shares of stock. Rather than buy the shares at the current price, however, they hope the put will be assigned and the shares will be purchased at a lower price.
In return for receiving a premium, the seller of a put assumes the obligation to buy the underlying stock at the strike price at any time until the expiration date. Stock options in the U.S. typically cover 100 shares. Therefore, in the example above, the investor receives $3.00 per share ($300 less commissions) and assumes the obligation to buy 100 shares of XYZ stock at $100 per share until the expiration date (usually the third Friday of the month). The net premium received can be used to purchase the shares, so the investor also deposits $97 per share ($9,700) cash in a money market account which, along with the $300 option premium, will be used to pay for the 100 shares of stock if the put is assigned.
If the stock price is below the strike price at expiration, then the put will be assigned. As a result, the investor will buy the shares and pay for them with the cash held in the money market account plus the option premium. If the investor still wants to own the stock, then the investor need do nothing. However, if the investor no longer wants to own the shares, then the stock must be sold. Alternatively, the investor could close the obligation to buy shares by buying the put in the market place prior to expiration and before an assignment notice is received.
If the stock price is above the strike price of the put at expiration, then the put expires worthless and the premium is kept as income. The investor must then decide whether to buy the stock at the current price or to sell another put or to invest the cash elsewhere.
Maximum profit
The potential profit is limited to the net premium received.
Maximum risk
Risk is substantial, because the stock price can fall to zero.
Breakeven stock price at expiration
Strike price minus premium received.
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