It is a highly effective income strategy that can also be used to buy stocks at bargain prices.
But selling cash-secured puts does have a couple of drawbacks:
- First, it's fairly expensive since you have to post a large cash margin deposit to ensure that you'll be able to follow through on the transaction if the shares are "exercised." Thus the name, "cash-secured" puts.
- Second, if the market - or the specific stock on which you sell the puts - falls sharply in price, you could have to buy the shares at a price well above their current value, taking a substantial paper loss.
It's called a "credit put spread" and it strictly limits both the initial cost and the potential risk of a major price decline.
I'll show exactly how it works in just a second, but first I have to set the stage...