How Traders Earn Passive Income From Cash Covered Puts

Posted by Mohan raj on August 20th, 2022

Futures and options are two types of derivative contracts. They are used not only to protect the equity position but also to make a steady income. Many traders and investors combine futures, call options, and put options to make regular money from the stock market. They do this by using their holdings and balance margin to start trades.

In this blog post, we'll look at how selling cash-secured puts can be used as a way to make money on the stock market.

Are you a regular trader? Then, Zebu’s lowest brokerage for intraday trading plans is what you need. As a share broking company, we understand that the lowest brokerage plans can help our users tremendously. 

How do cash-secured puts work?

As part of an option-selling strategy called "cash-secured put selling," you set aside enough money to buy a stock at a certain price and then sell the put option for that price. The goal is to buy the stock for less than what it is worth on the market.

There are, however, some risks involved. The first risk is that the price of the stock may never drop to the level where the trader wants to buy it. This could make it impossible to buy the stocks in the long run. The second risk is that the price of the stock could fall way below the strike price. 

Why selling cash-secured puts is a good idea

To make money from the option premium, cash-secured puts are usually sold. How much you get depends on the value of the security and how much you are willing to pay for it.

Gains Invested Quickly

Cash-secured puts can give you cash right away. It can make option income more appealing and can also help reduce risk.

You can get paid to invest 

A cash-secured put strategy is a great way to get paid to buy the stock you want to buy. This strategy lets you choose from a number of strike prices and expiration dates.

Low-dividend stocks can be profitable

If you want to increase your cash flow but don't want to be limited by a low dividend yield, you can do so by selling cash-secured puts.

Risks involved in this strategy:

Multiples of the Lot Size

Futures and options, which are examples of derivatives, can only be traded in lots. This method won't help you if you want to buy stocks in a very small amount or a fraction of the lot size.

Not being able to profit from price correction

Most investors who want to own shares of a company in the long run shouldn't use the cash-secured put strategy. If the price of shares stays high, they may never be able to buy any.

Repeated Actions

Most investors are more interested in a simple "buy and hold" strategy. In this strategy, you sell cash-secured puts so that you can buy stocks when the person who bought the put options decides to sell. Since the option doesn't have to be used, it takes more time to go through the same process every time it expires.

Effects on tax

When you sell cash-secured puts, the money you make is considered business income and is taxed based on the trader's tax slab. If the trader owned the stock, he or she would get money from dividends and the increase in value of the stock. Together, these two types of income might have a lower tax rate.

Getting to Know with an Example

Let's say that the price of Stock XYZ is Rs. 250 right now. Stock XYZ's derivatives contract has a lot size of 100 shares, and you want to buy 100 shares of XYZ for Rs. 235.

You can make money by selling the 235 strike price put option every month and keeping the premium. Let's say that for the current month, the premium for 235 put options is Rs. 8. You get Rs. 800 when you sell that put option (Rs. 8 x 100 shares).

This means that you are willing to buy 100 units of the stock XYZ for Rs. 235 at the end of the expiration period if the price at that time is Rs. 250 or less. For this obligation to buy, you need to keep an account balance of Rs. 23,500 (Rs. 235 x 100 shares).

If the stock price goes above Rs. 235, you get to keep the entire premium you got for selling the put option with a strike price of Rs. 2350.

The Bottom Line: Cash-secured put selling is a strategy that involves buying a security at a price that you would be willing to pay. This method works for people who want to make more money or feel safer without spending too much. You might not want to sell cash-secured puts because the deal is complicated and you don't want to own the security. This strategy could be better for investors and traders who want to make money on the stock market without doing much work.

If you are a regular trader then, Zebu’s lowest brokerage for intraday trading plans is what you need. As a share broking company, we understand that the lowest brokerage plans can help our users tremendously.