Last Updated on 2025-01-18 by Admin
A Cash-Secured Call (also known as a Cash-Backed Call) is a conservative options trading strategy that involves selling a covered call while having sufficient cash or liquid assets set aside to buy the underlying asset if the call is exercised. It’s similar to a covered call but instead of owning the underlying asset, the trader sets aside cash as collateral in case they need to buy the asset.
This strategy is typically used when the investor has a neutral to slightly bullish outlook on the underlying asset and aims to generate income from the premium received by selling the call option. The main difference between a cash-secured call and a standard covered call is that the cash-secured call does not require the investor to already own the underlying asset but instead uses cash to guarantee the potential purchase of the asset.
Key Elements
- Sell a Call Option: The investor sells a call option on a stock, index, or other asset. This gives the buyer of the call the right, but not the obligation, to buy the underlying asset at the call’s strike price.
- Cash Reserve: The investor sets aside enough cash to purchase the underlying asset if the option is exercised by the buyer. This amount should be equal to the strike price of the call option multiplied by the number of shares (or units of the asset) per contract (typically 100 shares per contract for stocks).
- Neutral to Slightly Bullish Outlook: The investor sells the call option because they believe the asset’s price will either remain stable or increase slightly, but they don’t necessarily want to own the asset outright. They expect that the call will expire worthless or be exercised at a price higher than the market value.
- Premium Income: By selling the call option, the investor collects a premium upfront, which represents the income from the strategy. This premium is kept regardless of whether the option is exercised.
Objective
The objective of a cash-secured call is to generate income through the premiums received from selling the call option while maintaining the ability to purchase the underlying asset if the call is exercised. It’s a neutral to slightly bullish strategy that allows an investor to earn money in a relatively flat or mildly rising market, without having to own the underlying asset in advance.
Mechanics
- Sell a Call Option: The trader sells a call option with a specific strike price and expiration date. This obligates them to sell the underlying asset at the strike price if the buyer chooses to exercise the option.
- Set Aside Cash: The trader sets aside cash equivalent to the strike price of the call option (multiplied by 100 for each options contract). This cash will be available to buy the underlying asset if the call option is exercised.
- Receive Premium: The trader collects the premium from selling the call. This premium is theirs to keep whether or not the option is exercised.
- Expiration or Exercise:
- If the underlying asset remains below the strike price: The call option expires worthless, and the investor keeps the premium as profit.
- If the underlying asset rises above the strike price: The buyer of the call may exercise the option, and the seller (the trader) will need to purchase the underlying asset at the current market price (if they don’t already own it) and sell it to the option holder at the strike price. The trader’s profit comes from the premium received plus any potential price appreciation up to the strike price.
Maximum Profit
The maximum profit in a cash-secured call strategy is limited to the premium received from selling the call option. Even if the price of the underlying asset rises significantly, the maximum profit is capped at the strike price plus the premium received.
Mathematically:
- Maximum Profit = Premium Received + (Strike Price – Purchase Price) (if the trader already owns the underlying asset).
Maximum Loss
The maximum loss occurs if the price of the underlying asset falls to zero. This is because the trader still holds the cash-secured position but has no offsetting premium income (if the option expires worthless and the asset becomes worthless).
However, because the trader has set aside the cash to buy the asset, the maximum loss is limited to the full price of purchasing the underlying asset at the strike price (which would occur if the call is exercised).
Mathematically:
- Maximum Loss = Amount Paid for Underlying Asset (if exercised at strike price and the asset’s value falls).
Breakeven Point
The breakeven point is the price at which the investor will not make a profit or loss from the strategy. It is calculated by taking the strike price of the call and subtracting the premium received from selling the call option.
Mathematically:
- Breakeven = Strike Price of the Call – Premium Received.
Example
Let’s assume a stock is currently trading at $50, and you want to sell a cash-secured call on this stock:
- Sell a Call Option: You sell a call option with a strike price of $55, expiring in one month, for a premium of $2 per share.
- Set Aside Cash: Since the strike price is $55, you need to set aside $5,500 ($55 x 100 shares) in cash to cover the purchase of the stock if the option is exercised.
- Premium Received: You collect $2 per share, so you receive $200 (100 shares x $2).
Outcomes
- If the stock price stays below $55:
- The call option expires worthless, and you keep the $200 premium as profit. You don’t need to buy the stock.
- If the stock price rises to $60:
- The call option is exercised, and you are obligated to sell the stock at $55.
- You will buy the stock at market price ($60) and sell it at $55.
- The net loss is the $5 difference in price minus the $200 premium received.
- In this case, the loss is mitigated by the premium received, but there is still a net loss because you had to buy at $60 and sell at $55.
- If the stock price rises to $55:
- The option is exercised, and you sell the stock at $55. You effectively break even because you set aside $5,500 to purchase the stock, and the $200 premium received offsets the cost of the transaction.
Risk/Reward Profile
- Maximum Loss: The maximum loss occurs if the price of the underlying asset drops to zero. This results in a complete loss of the value of the underlying asset, minus the premium received.
- Maximum Profit: The maximum profit is limited to the premium received from selling the call, as the trader cannot earn more than the premium if the stock rises above the strike price.
- Breakeven Point: The breakeven point is the strike price of the sold call minus the premium received.
When to Use
- Neutral to Slightly Bullish Outlook: This strategy is used when the investor believes the price of the underlying asset will either remain stable or increase slightly. The premium received from selling the call provides income, and the strategy works well in a moderately bullish or flat market.
- Income Generation: The strategy is ideal for income generation because it allows the investor to earn premium income by selling the call option. This is particularly useful when the investor is not expecting significant movement in the underlying asset and seeks additional income.
- Limited Capital Risk: For investors who are hesitant to buy the underlying asset outright but still want to profit from slight upward movements, the cash-secured call offers a way to use cash as collateral instead of needing to buy the asset upfront.
Pros
- Income Generation: The premium received from selling the call option provides immediate income, which is especially appealing in a neutral market.
- Limited Risk: The strategy has limited risk, as the investor sets aside cash to buy the stock if necessary. However, the risk is limited to the decline in the stock’s value.
- No Need to Own the Asset: Unlike a covered call, the investor does not need to own the asset upfront, as they are using cash as collateral.
- Ideal for Sideways or Slightly Bullish Markets: This strategy works well in flat or mildly bullish markets where the stock price is not expected to rise dramatically above the strike price.
Cons
- Limited Profit Potential: The maximum profit is capped at the premium received, meaning the investor cannot benefit from any price increase above the strike price.
- Cash Requirement: The strategy requires the investor to set aside enough cash to purchase the underlying asset if the option is exercised, which can tie up a significant amount of capital.
- Opportunity Cost: If the underlying asset rises above the strike price, the investor is forced to sell at the strike price, potentially missing out on higher gains.
- Risk of Loss: If the underlying asset’s price falls significantly, the investor may incur a loss on the asset itself, although this loss can be offset by the premium received.
Example Summary
- Stock Price: $50
- Sell Call Option with a Strike Price of $55
- Premium Received: $2 per share
- Set
Aside Cash: $5,500 to buy the stock if exercised
- Maximum Profit: $200 (premium received)
- Maximum Loss: Limited to the amount paid to purchase the asset if the stock price falls to zero.
- Breakeven: $53 (strike price of $55 – premium received)
Conclusion
A cash-secured call is a conservative options strategy that generates income through the premiums received from selling call options while setting aside cash to cover the potential purchase of the underlying asset if the option is exercised. It is best used in a neutral to slightly bullish market, where the investor expects little movement or slight appreciation in the asset’s price. The strategy offers limited risk, as the cash set aside can be used to purchase the asset if necessary, but the profit potential is capped at the premium received.
