Cash secured puts and the wheel

Selling a put with cash set aside is a paid promise to buy stock at a price you chose. The wheel chains that promise to a covered call. Both deserve a full accounting.

A cash secured put is a promise to buy 100 shares at a price you name, on or before a date, if the other side wants you to, with the cash set aside to keep the promise. Someone pays you for making it. The word "secured" is about the cash, not about safety.

A made up example

A stock trades at $52. You sell a put with a $48 strike expiring in 30 days for $0.90 per share, collecting $90, and you set aside $4,800. If the stock stays above $48, the put expires worthless and you keep $90 on $4,800 of parked cash, about 1.9 percent for the month. If the stock falls to $45, you are made to buy 100 shares at $48, paying $4,800 for stock worth $4,500. Your real cost is $48 minus $0.90, or $47.10 a share, against a market price of $45. If the stock falls to $30, you still buy at $48. The $90 was payment for a loss of $1,710.

The payoff at expiration is the exact same shape as a covered call at the same strike, a fact called put call parity. A sold put with cash equals owned stock plus a sold call. This is not a coincidence, and it means anyone who believes cash secured puts are safer than covered calls is comparing two versions of the same bet. The differences are practical: which is easier to enter, how brokers treat the margin, dividends, and taxes.

The wheel is a routine: selling puts until you are made to buy, then selling covered calls on those shares until they are taken away, then selling puts again. It produces a steady trickle of premiums and a steady stream of decisions. Its weakness is the weakness of every approach that sells options: the premiums are small and regular while the losses, when they come, are large and irregular. A stock that drops 40 percent after you are made to buy it leaves you holding shares far below the strike, selling calls that lock in a loss or waiting a long time to get back to even.

Margin and funding

"Cash secured" means the full strike times 100 is sitting in cash. Some brokers let you sell puts with less set aside, sometimes called naked puts, which multiplies both your leverage and your chance of a margin call. The promise is identical. Only the funding differs, and the funding is where people get hurt.

Where the tidy version goes wrong

"I only sell puts on stocks I would be happy to own at that price" is the standard comfort. It is sensible as far as it goes. It does not ask whether you would still be happy to own it at that price after the reason for the drop became public. Being forced to buy at $48 a stock now at $40 because of a terrible earnings report is not the same as choosing to buy at $48 on a quiet afternoon.

Questions worth asking yourself

What is the most you can lose, and is it the full strike value minus the premium? Is the cash truly set aside, or is the broker lending? Why is the premium the size it is? If you are made to buy, what is your plan for the shares? And how does the premium compare, after fees, to simply holding a Treasury bill for the same month?

Sources

Written by one person and checked against the sources above; no outside expert has reviewed it yet. Rules and dollar limits change every year, so this guide explains how things work and sends you to the official source for this year's numbers.