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In this video I would be showing you a Cash Secured Put trade that I took recently and how I adjusted the trade as things went against me.
But before we dive into the details let's take a quick recap of what a cash secured put strategy really is.
Cash Secured Put is an options strategy where you can actually get paid to acquire the stock before you ever own it. It is a way to lower the cost basis of a stock you wish to acquire.
However, it can also be looked at as a good income strategy. In fact, Cash Secured Put is one of the few income strategies that help you generate a regular income on a consistent basis.
The strategy involves the following steps.
Find a stock you would like to acquire.
[I recommend to limit yourself to sector leaders and fundamentally strong stocks. Some of the examples would be HDFC Bank, Reliance, Hindustan Unilever Ltd., TCS, Asian Paints, etc.]
Determine the price at which you would be willing to purchase the stock.
[Find a zone that has been a good support historically for the stock]
Sell a put option with a strike price near your desired purchase price.
[Remember that selling a put option obligates you to buy shares of a stock at your chosen short strike if the put option is assigned, that is, if the put option expires in the money.]
Have enough cash in your brokerage account to cover the purchase of the stock if the put is assigned.
Collect (and keep) the premium from the sale of the put, while you wait for the stock to fall in price to the point that you are put into the stock.
[If the stock consolidates or goes a little lower or goes up, you repeat the trade, collect the premium and wait and see what happens.]
Now to the topic of the video.
On Sep 18th, 2020, I sold the October 29th expiry 170 Put option of ITC at 3.5 when it was trading at 179 levels as I felt ITC will find support at 170.
The stock has constantly been trading in a down trend and highly oversold with RSI at 30 levels.
I thought this has to be the bottom and the stock would recover, and go up again. The lot size of ITC is 3200, so the maximum profit I can make on the trade is 3200 x 3.5, which comes to about ₹11200.
Risk graph:
It is clear from the risk graph that the maximum profit at expiry is ₹11200 and the break even point at expiry is at 166.5. The graph also shows that the upside is limited to the initial premium received, while there is an unlimited downside.
But what happened next was contrary to my expectations, the stock continued to move south and on Oct 9th, 2020, the sold put option was trading at 6.4 and I was sitting on an unrealized loss of Rs. 9280.
At this juncture, I initiated a bear put spread trade, that is, I sold another lot of the 170 strike price Put option at 6.4 and bought one lot of the 172.5 strike price Put option at 8.25.
The bear put spread is a debit spread that involves buying a higher strike put option and then writing a lower strike put option. It is a bearish trade and hence benefits from a falling market. Let’s take a quick look at the risk graph of the bear put spread.
It is clear from the risk graph that the maximum profit at expiry is ₹2080 and the maximum loss at expiry is ₹5920.
So, when this bear put spread is combined with the cash secured put it not only pushes the break even point down but also increases the max profit.
Risk graph:
It is clear from the risk graph that the maximum profit at expiry has now gone up to ₹13280 and the break even point at expiry has been pushed down to 165.8. The graph also shows that the upside profit above 172.5 has now come down to Rs. 5280, while there is still an unlimited downside.
The idea was if ITC continues to move down, I would close the bear put spread in a profit and roll over the 170 Put to the next month. Else, if ITC recovers a little, I would exit with a small profit.
ITC recovered to some extent post the adjustment and on Oct 26th, 2020, I closed the trade with a Rs. 4640 profit.
The total margin required for the bear put spread + cash secured put strategy is about Rs. 1.6 lakh. So the ROI is about 2.9%.
Some Takeaways:
Remember that this is only one of the few ways to adjust a losing Cash Secured Put trade, I would be showing you several other ways to adjust a troubled cash secured put trade in future videos.
An adjustment would usually require an additional amount of capital, so be prepared for that.
Cash Secured Put is a good setup for those who wish to lower the cost basis on the stock they want to buy.
Do the strategy only on stocks you like and on stocks you are comfortable holding for longer periods of time.
You should ideally enter the strategy when the stock you chose is at a low point and you see an upside potential.
Do not enter the strategy when the stock you chose is in an overbought region.
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