What is the downside cushion for a covered call or cash-secured put?
The downside cushion is the percentage drop in the underlying that the premium can absorb before the position is in unrealized loss; it is a quick "how much margin of safety did I sell at this strike" check.
Formula
breakeven = cost basis − premium per sharecushion = (current price − breakeven) ÷ current priceWhen cost basis equals current price, this simplifies to:
cushion = premium per share ÷ current priceCash-secured put (no existing position; assignment gives you shares at strike):
effective cost basis if assigned = strike − premium per sharecushion vs. current price = (current price − effective cost basis) ÷ current price
Worked examples
Covered call, cost basis = current price: You own 100 shares of a stock at $100, sell a 30-day call for $2.00 premium. Breakeven = $100 − $2.00 = $98.00. Cushion = ($100 − $98) ÷ $100 = 2%. Interpretation: the stock can drop 2% before your position is at unrealized loss net of premium collected.
Covered call, cost basis below current: You own 100 shares bought at $80 (cost basis), now trading at $100, and sell a 30-day call for $2.00. Breakeven = $80 − $2 = $78. Cushion from current = ($100 − $78) ÷ $100 = 22%. The realized cushion is larger because you're already sitting on unrealized gains.
Cash-secured put: Sell a 30-day $95 put on a $100 stock for $1.50 premium. Effective cost basis if assigned = $95 − $1.50 = $93.50. Cushion from current = ($100 − $93.50) ÷ $100 = 6.5%.
Common misinterpretation
Treating downside cushion as "how much downside I am protected against." If the stock drops 10% in 30 days, you are still long the underlying; the premium only offsets a fixed dollar amount of the paper loss (in the worked example above, $2.00 per share). Cushion is the price drop at which you start to lose money net of premium collected — not the price drop you are insured against. Also note: the call strike determines capped upside and assignment economics; it does not determine the covered call's downside breakeven. The downside breakeven is cost basis − premium − dividends received.
Limitations
- Linear approximation — does not account for the change in option value during the cycle.
- Assumes you hold to expiration; closing early changes the realized cushion.
Tools that use this metric
Primary references
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Educational only — not investment advice. See the disclaimer and methodology. Material methodology corrections are logged at corrections.