Cash Secured Puts vs. Covered Calls

Many investors use derivatives like options to make outsized profits during high volatility. But options can also be used to leverage bouts of lowvolatility and allow investors to pocket income while markets are flat. Two more popular options strategies are cash-secured puts and covered calls, where options are written and balanced with cash or stock to minimize risk.

While these strategies are similar in risk profile, a few differences could make one more advantageous than the other in specific markets. These options strategies are relatively easy to understand, but trading derivatives requires experience and expertise and isn’t recommended for novice investors.

What Are Cash-Secured Puts?

A cash-secured put is a trade where an investor writes a put option on a particular stock and then secures the position by having enough cash reserves in their account to cover the purchase of shares should the assignment occur. The amount of cash to secure the position is equal to 100 shares of stock at the option's strike price so that the investor can buy the stock should the option be exercised.

Here’s an example: Company CBA trades at $10 per share. If you expect the price to remain near that level, you could sell a put option with a $9 strike price and fund your account with cash to cover the position should the option be exercised ($900 minus whatever premium you obtained from selling the option). If the stock price stays at $10 through the life of the contract, the option will expire worthless, and you can pocket the premium. If the stock drops to $9, you would use your cash position to purchase the stock in case of assignment. The maximum profit for the trade is the premium from selling the option.

What Are Covered Calls?

A covered call is a strategy similar to a cash-secured put in terms of risk and profit ranges, but you own the underlying stock. It’s two trades — 100 shares of stock are purchased and then a call option with a strike price at the purchase price of the stock. If the stock declines, the option will expire worthless, and you keep the premium. If the stock increases, you can match your assignment risk with the shares you own. Max profit is the premium from the option, and while downside risk is minimized, you won’t benefit from any potential stock price appreciation.

If Company CBA trades at $10, you can execute a covered call by buying 100 shares and selling a call option with a $10 strike price. If the stock stays at $10 or declines, the option will expire worthless, and you can keep the premium. Losses on the overall position will be lower than just owning the stock outright. If the stock goes to $12 and the option is exercised, you can cover your assignment with the 100 shares in your account.

Similarities Between Cash-Secured Puts and Covered Calls

Cash-secured puts and covered calls are different types of protective trades, but they also have many similarities. Here’s how both options strategies can be beneficial to your portfolio:

Require Investors to be Skilled

While these are two more straightforward market-neutral options trades, using derivatives requires a particular proficiency as an investor, especially when selling options instead of buying them. Always understand the construction of the trade before risking any capital with options.

Additional Income to Your Portfolio

Cash-secured puts and covered calls may sound like they have different goals, but the ideal outcome is the same: extra income during flat markets. In both trades, the primary profit source is the option premium received, and the upside is limited compared to direct ownership of the underlying stock.

Profit and Loss Graphs

Both trades have similar risk profiles, which is evident when looking at the graph of potential outcomes. Breakeven points are similar, upside is limited, and max profit is the option premium. Risk is minimized but so are potential returns.

ETF or Stock Selection Process

Selecting securities for these trades involves a similar process. Because the benefits of stock price appreciation are limited, the ideal securities are low-volatility stocks and exchange-traded funds (ETFs) with liquid options markets. One particular selection technique is the Wheel Strategy, which combines cash-secured puts and covered calls for a consistent income stream.

Conservative Option Strategies

In terms of risk and profit, these are two reasonably conservative strategies for options trades. The downside is limited because the stock is owned or cash-secured, and gains are limited. Both techniques are ideal for markets with low volatility.

Differences Between Cash-Secured Puts and Covered Calls

The key to successfully using cash-secured puts and covered calls is understanding the slight differences between the two trades and knowing when to use each. Here are the key factors that distinguish the two strategies:

Primary Motives

An investor using a cash-secured put has a neutral slant but also looks for an opportunity to purchase shares at a lower market price. A covered call is better for an investor who already owns the underlying stock.

Market Outlook

While both trades can benefit a neutral market, cash-secured put sellers have a more bearish slant than covered-call sellers. But covered call sellers can make money in slightly rising markets if the call option strike price is above their purchase price, so the mindset is more bullish.

Possible Profits

Cash-secured put sellers can only make a profit from the option premium. However, covered-call sellers can profit from option premiums and stock dividends and appreciation if the call's strike price is above the purchase price of the stock.

Dividends

A covered call strategy will allow you to collect dividends because you own the underlying stock. While a cash-secured put requires a similar level of capital, you don’t own the stock, so no dividends are paid. 

Self-Directed IRAs

If investing in a self-directed individual retirement account (IRA), you must check with your broker to see whether cash-secured put writing is allowed. Covered call writing is Financial Industry Regulatory Authority (FINRA)-regulated and usable in all self-directed IRAs.

Both Strategies Have Similar Risk Profiles But Also Subtle Differences

The differences may be subtle, but they should be well-understood to maximize the benefits of both strategies. For example, a covered call is likely the superior trade if you already own the stock because you don’t need to make two transactions to open the trade. If you don’t own the stock and think you can get shares cheaper in the future, a cash-secured put might be better because transaction costs are lower. Consider your own risk tolerance and investment goals when deciding between the two strategies.

Frequently Asked Questions