What You Need to Know About Cash Secured Equity Puts (CSEPs)
In an era of substantial economic uncertainty regarding inflation, geopolitical issues, and an increasingly hawkish Fed, more and more investors are feeling uneasy about the markets. Whether you have been investing for years, or maybe you have cash on the sidelines, the days of markets seemingly only going up appears to be in the past. So, how can you navigate this period while still remaining a disciplined, long-term investor? Selling Cash Secured Equity Puts (CSEPs), has now entered the chat.
If you are new to options, feel free to check out our options article for an overview of what they are. CSEPs are made by selling puts with cash on the sidelines. Remember, in options land, think of it like insurance. There are individuals who buy insurance and there are individuals who sell insurance. In this case, you are the insurance underwriter who sells the policy, and in this case, it’s a Put. You are getting paid to insure someone on the other side of the contract that you will buy their stock/ETF in the event that the underlying stock/ETF falls at or below a particular agreed-upon price (the strike price). Why it is called a Cash Secured Equity Put (CSEP) is that if you end up having to buy that underlying security, you are able to do so because you have already earmarked that cash in your account.
Using The CSEPs Options Strategy
Although selling puts and how they are used can vary by the portfolio manager, how we typically like to use them at MDRN Wealth is like a limit order that you get paid to wait with. Once you have done a comprehensive plan and understand the longer-term design of your portfolio, we then know what pieces need to be plugged into that portfolio.
Depending on market conditions, maybe we don’t want to buy certain pieces all at once. Maybe we want to wait a little while to buy a particular piece, but we don’t want to just have the cash dedicated to this purchase not working for us. This is where the CSEPs come into play.
Let’s say that piece is a particular Large Cap ETF. Maybe Large Cap stocks at the time seem expensive or maybe you would feel more comfortable slowly dipping your toes into the water, rather than buying it all at once. This is when we would identify a price we would be willing to buy in at and sell a put at that strike price. If that Large Cap ETF never falls below that strike price, we pocket 100% of the income we received from selling that put. If, however, that Large Cap ETF does fall below the strike price, we may be forced to buy it. Ideally, this is a mutually beneficial transaction. The entity that bought the put from us is happy they could exit the position at a particular agreed-upon price, and you bought in at a cheaper price than when you originally sold the put.
For this example, we will look at Microsoft. All data mentioned is as of market close, 8/18/2022.
Let’s say we wanted to buy Microsoft but did not want to buy in at $290.17. Perhaps that is a little too expensive in our minds. We decide that $270 is a more reasonable price. We elect to write/sell a put with a strike price of $270 that expires on 11/18/2022. It looks like we could sell this put and someone out there would potentially buy it for $7.75 a share, or $775 for a single contract. We go ahead and sell the put, take in our $775 in premium, and wait. If Microsoft never falls below $270 a share between now and 11/18/2022, we pocket $775 in premium without ever having to buy the stock. If however, between now and 11/18/2022 Microsoft falls at or below $270, we could be forced to buy the stock at that price. If at contract expiration the stock is at or below $270, we will be forced to buy it.
The key thing to understand with this CSEPs strategy is that you are writing/selling the put on whatever position it is because you want to own it. You are also accepting the risk that you will buy the stock at that strike price, no matter what happens to the stock.
In our example, Microsoft could fall to $5 a share and we would still need to buy it from the entity on the other side of the contract at a price of $270 a share. This is why comprehensive planning and working with an experienced portfolio manager in this space is so crucial. It is critical that you not only know if this CSEPs strategy makes sense for you, but also:
- What positions to sell the puts on
- What strike prices to look at
- What expiration dates to look at
- What current options pricing market-wide looks like
- How the position ultimately fits into your overall portfolio if you end up buying it
Is The CSEPs Options Strategy Right for You?
Using CSEPs can be a powerful way to generate yield on idle cash while you wait to potentially purchase a position you want. In our Microsoft example, the annualized yield on our cash earmarked for the Microsoft purchase is roughly 11%. If you feel that you would benefit from incorporating CSEPs or alternative strategies and asset classes within your portfolio, please set up some time to discuss it with us further.