A Comparison of Cash Secured Put vs Covered Call [P&L and Examples]

When looking at a company you like, there are different ways to invest in it other than simply buying shares. This article explores cash secured puts vs. covered calls, highlighting how the investors’ motives and market outlooks differ between these two strategies.

Key takeaways

• There is no real difference between a cash secured put vs a covered call from the point of view of the market outlook: both strategies are bullish and have the same P&L.
• A covered call is better for longer term positions or collect a dividend, while selling puts is a good way to hold cash as a shorter term position.
• Cash-secured puts can only result in profit from the option premium, while covered calls have potential profits from both option premiums and stock dividends/appreciation.

Cash Secured Put vs Covered Call – The Key Differences

Covered calls and cash secured puts are popular options strategies that can provide additional income and are easy to implement. Here’s a table that summarizes the main aspects for you for the cash-secured put vs covered call debate:

What Is a Cash Secured Put?

A cash-secured put involves writing a put option on a particular stock and securing the position with enough cash reserves to cover the purchase of shares should the option be exercised. The amount of cash required is equal to 100 shares of the stock at the option’s strike price. If the stock’s price remains above the strike price, the option expires worthless, and the investor keeps the premium. If the stock price drops below the strike price, the investor buys the stock at the lower price.

What Is a Covered Call?

A covered call is a strategy where an investor owns the underlying stock and sells a call option on it. This involves buying 100 shares of a stock and selling a call option with a strike price at or above the purchase price. If the stock’s price remains flat or declines, the investor keeps the premium, and the option expires worthless. If the stock’s price rises above the strike price, the investor sells the shares at the strike price, securing the option premium plus any capital gains up to the strike price.

Cash Secured Put vs Covered Call – The Differences You Should Know

• Primary Motives: An investor using a cash-secured put has a neutral outlook but is prepared to buy shares at a lower price. A covered call suits an investor who already owns the stock and seeks to earn extra income from the option premium.
• Market Outlook: Choosing a cash secured put vs covered call requires to consider your outlook on the market (or, at least, on a company). Both trades have definitely a bullish orientation.
• Possible Profits: Cash-secured put sellers profit only from the option premium. Covered call sellers can profit from both the option premiums and any stock dividends or appreciation if the stock price rises above the strike price.
• Dividends: When debating cash secured put vs covered call, dividends are an aspect you cannot ignore. Covered calls allow investors to collect dividends since they own the underlying stock. Cash-secured puts do not offer this benefit as the stock is not owned unless the option is exercised.
• Time Horizon: Usually, a covered call is better for longer term positions, while the cash secured put will work best for shorter term operations, especially considering what we said above about dividends.

An Example of a Cash Secured Put

The easiest way to understand the cash secured put vs covered call scenarios is by “getting our hands dirty” with a couple of examples. Let’s begin with a cash secured put example to highlight how this strategy works. Imagine you have read bullish reports on Dell Technologies (DELL), currently trading at $137.66.

Suppose that analysts have been upgrading their target prices on the company, and you see a solid trading opportunity. However, you believe there is a chance DELL’s price might dip before resuming its upward trend. You would prefer to add DELL to your portfolio at $125 rather than $137.66. This scenario is ideal for a cash secured put.

On our options screener, this strategy is referred to as a “naked put,” though it’s often used interchangeably with “cash secured put.” The main difference is that with a cash secured put, you set aside the necessary funds to buy the shares if assigned, but that’s more of a “textbook” difference. Here’s how it may work with DELL:

• Sell a Put Option: Sell a $125 put option on DELL, expiring in two weeks.
• Set Aside Cash: Ensure you have enough cash in your account to buy 100 shares at $125 each if the option is exercised (i.e., $12,500).
• Collect Premium: You collect the premium of $70 from selling the put option.

Note that, in this case, your return would be equal to the premium you receive (the mid-price is $0.85) divided by the strike price ($125), hence roughly 0.7%. We can annualize this return to 19.9%.

P&L and Possible Outcomes

Take a look at the trade’s P&L profile below from our options screener:

So, here is what could happen:

• Stock stays above $125: If DELL remains above $125 by the expiration date, the put option expires worthless. You keep the $70 premium, and no shares are purchased.
• Stock falls below $125: If DELL drops below $125, you may be assigned the shares. Your breakeven price is $124.30 ($125 strike price – $0.70 premium). You end up owning DELL shares at an effective price of $124.30 each.

Analyzing the Price Chart

Before executing this trade, it’s wise to analyze DELL’s stock chart:

Look for support levels around $125. Historical data shows that DELL has struggled to move below $125, suggesting it may hold this level again.

If you understand these dynamics, you can effectively use cash secured puts to enhance your portfolio, balancing risk and reward based on your market outlook and investment goals. We gave you a rather practical approach to open an options trade, just make sure you do your homework before by carefully researching the company. You can also use our “High probability naked puts (85% prob of worthless, good companies, good risk-return profile)” predefined scan (you’ll find a link to it at the end of the article) to speed up the process, but this does not mean you should skip doing your own analysis.

An Example of a Covered Call

What if you wanted to open a covered call on DELL? Let’s use DELL as an example again, as this will help us compare covered calls and cash secured puts in a direct way.

Assume this is a company you like due to its good fundamentals, and analysts have been praising its business lately. An easy way to understand the cash secured put vs covered call trade is to learn how to invest in DELL differently compared to the example we mentioned earlier. With a covered call, you could do the following:

• Buy 100 Shares: Purchase 100 shares of DELL at $137.66 each.
• Sell ITM Call: Sell a $130 call option expiring in five weeks.

In terms of return, if we imagine that the stock price ends up being above $130 (say, for instance, $140) by the time your call expires, here is what you can expect:

• % Return: roughly 4.06% (because you want to divide the net profit by the initial cost of buying the shares. The initial cost is $137.66 times 100, hence $13,766, while the net profit is the total income from the stock sale and option premium minus the initial cost, so $559).
• Annualized % Return: If we annualize the 4.06% above, we obtain a 51.3% return.

Selling this call option provides you with an immediate premium, which adds to your overall profitability.

P&L and Possible Outcomes

Here is what your P&L would look like from the trade you’d find on our “Safe covered calls (profitable & good companies, growing, high yield, margin of safety)” predefined scan (again, we added the link to the scan at the bottom of the article):

To understand the potential outcomes, let’s break down the P&L:

• Stock stays above $130: If DELL’s stock price stays above $130 at expiration, the call option will be exercised. You would sell your shares at $130, earning a profit from the call premium and the difference between your purchase price and the strike price.
• Stock falls below $130: If DELL’s stock price drops below $130, the call option expires worthless. You keep the premium but incur a loss on the stock purchase. However, this loss is mitigated by the premium received.

Analyzing the Price Chart

Look at the price chart once again:

And again, we are putting our breakeven point close to the $125 threshold, which has acted as support/resistance in the past. This historical level can give you confidence that the stock is less likely to dip significantly below this point, making it a logical trading idea. So, when it comes to covered calls vs cash secured puts, you can actually obtain a similar risk position with slightly different goals.

Cash Secured Put vs Covered Call – Picking the Right Strategy in the Right Moment

Having seen the two examples above, it is now easier to draw some conclusions on when to use a cash secured put vs covered call strategy.

Market Conditions

Choosing between covered calls vs cash secured puts often depends on the market conditions. Both strategies benefit from bullish conditions, but a cash-secured put will leave the door open for a potential share assignment at a lower price if the stock price moves below the strike price, while a covered call requires you to buy the shares at once and sell a call right away.

By owning the underlying stock, you can capitalize on both the premium from selling the call option and any appreciation in the stock price. In low-volatility markets, both strategies (cash secured put vs covered call) can provide a steady income stream, but understanding the market’s direction can help you select the optimal strategy.

Investor Goals

Investor goals and risk tolerance are crucial in the decision-making process. If your goal is to invest for the longer term, maybe a covered call will be the wisest choice (think, for instance, about the fact that you can receive a dividend). However, if you’re thinking about a shorter term position, the cash secured put works best.

When looking at choosing between covered calls vs cash secured puts, consider that, if you own shares and seek to generate extra income with a bullish outlook, covered calls are a suitable choice. This approach lets you benefit from premiums and potential stock gains. Understanding your investment goals, whether it is acquiring new stocks or maximizing returns on existing holdings, will guide you in choosing between covered calls and cash secured puts.

Read More

High probability naked puts (85% prob of worthless, good companies, good risk-return profile) – Predefined Scan
Safe covered calls (profitable & good companies, growing, high yield, margin of safety) – Predefined Scan