Put Spreads Explained

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Put Spreads

A put spread is an option spread strategy that is created when equal number of put options are bought and sold simultaneously. Unlike the put buying strategy in which the profit potential is unlimited, the maximum profit generated by put spreads are limited but they are also, however, relatively cheaper to employ. Additionally, unlike the outright purchase of put options which can only be employed by bearish investors, put spreads can be constructed to profit from a bull, bear or neutral market.

Vertical Put Spread

One of the most basic spread strategies to implement in options trading is the vertical spread. A vertical put spread is created when the short puts and the long puts have the same expiration date but different strike prices. Vertical put spreads can be bullish or bearish.

Bull Vertical Put Spread

The vertical bull put spread, or simply bull put spread, is used when the option trader thinks that the underlying security’s price will rise before the put options expire.

Bear Vertical Put Spread

The vertical bear put spread, or simply bear put spread, is employed by the option trader who believes that the price of the underlying security will fall before the put options expire.

Calendar (Horizontal) Put Spread

A calendar put spread is created when long term put options are bought and near term put options with the same strike price are sold. Depending on the near term outlook, either the neutral calendar put spread or the bear calendar put spread can be employed.

Neutral Calendar Put Spread

When the option trader’s near term outlook on the underlying is neutral, a neutral calendar put spread can be implemented using at-the-money put options to construct the spread. The main objective of the neutral calendar put spread strategy is to profit from the rapid time decay of the near term options.

Bear Calendar Put Spread

Investors employing the bear calendar put spread are bearish on the underlying on the long term and are selling the near term puts with the intention of riding the long term puts for a discount and sometimes even for free. Out-of-the-money put options are used to construct the bear calendar put spread.

Diagonal Put Spread

A diagonal put spread is created when long term put options are bought and near term put options with a higher strike price are sold. The diagonal put spread is actually very similar to the bear calendar put spread. The main difference is that the near term outlook of the diagonal bear put spread is slightly more bearish.

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Bear Put Spread

What Is a Bear Put Spread?

A bear put spread is a type of options strategy where an investor or trader expects a moderate decline in the price of a security or asset. A bear put spread is achieved by purchasing put options while also selling the same number of puts on the same asset with the same expiration date at a lower strike price. The maximum profit using this strategy is equal to the difference between the two strike prices, minus the net cost of the options.

As a reminder, an option is a right without the obligation to sell a specified amount of underlying security at a specified strike price.

A bear put spread is also known as a debit put spread or a long put spread.

Key Takeaways

  • A bear put spread is an options strategy implemented by a bearish investor who wants to maximize profit while minimizing losses.
  • A bear put spread strategy involves the simultaneous purchase and sale of puts for the same underlying asset with the same expiration date but at different strike prices.
  • A bear put spread nets a profit when the price of the underlying security declines.

The Basics of a Bear Put Spread

For example, let’s assume that a stock is trading at $30. An options trader can use a bear put spread by purchasing one put option contract with a strike price of $35 for a cost of $475 ($4.75 x 100 shares/contract) and selling one put option contract with a strike price of $30 for $175 ($1.75 x 100 shares/contract).

In this case, the investor will need to pay a total of $300 to set up this strategy ($475 – $175). If the price of the underlying asset closes below $30 upon expiration, the investor will realize a total profit of $200. This profit is calculated as $500, the difference in the strike prices [$35 – $30 x 100 shares/contract] – $300, the net price of the two contracts [$475 – $175] equals $200.

Advantages and Disadvantages of a Bear Put Spread

The main advantage of a bear put spread is that the net risk of the trade is reduced. Selling the put option with the lower strike price helps offset the cost of purchasing the put option with the higher strike price. Therefore, the net outlay of capital is lower than buying a single put outright. Also, it carries far less risk than shorting the stock or security since the risk is limited to the net cost of the bear put spread. Selling a stock short theoretically has unlimited risk if the stock moves higher.

If the trader believes the underlying stock or security will fall by a limited amount between the trade date and the expiration date then a bear put spread could be an ideal play. However, if the underlying stock or security falls by a greater amount then the trader gives up the ability to claim that additional profit. It is the trade-off between risk and potential reward that is appealing to many traders.

Less risky than simple short-selling

Works well in modestly declining markets

Limits losses to the net amount paid for the options

Risk of early assignment

Risky if asset climbs dramatically

Limits profits to difference in strike prices

With the example above, the profit from the bear put spread maxes out if the underlying security closes at $30, the lower strike price, at expiration. If it closes below $30 there will not be any additional profit. If it closes between the two strike prices there will be a reduced profit. And if it closes above the higher strike price of $35 there will be a loss of the entire amount spent to buy the spread.

Also, as with any short position, options-holders have no control over when they will be required to fulfill the obligation. There is always the risk of early assignment—that is, having to actually buy or sell the designated number of the asset at the agreed-upon price. Early exercise of options often happens if a merger, takeover, special dividend or other news occurs that affects the option’s underlying stock.

Bull Put Spread Explained (Best Guide w/ Examples)

October 11, 2020 By Chris

Bull Put Spread Explained – The Ultimate Guide

A bull put spread is an options strategy that consists of selling a put option while also buying a put option at a lower strike price.

Both options must be in the same expiration cycle. Additionally, each strike should have the same number of contracts (i.e. if selling two puts, two puts at a lower strike should be bought). Selling put spreads is similar to selling naked puts, but far less risky due to buying a put against the short put. As the name suggests, a bull put spread is a bullish strategy, as it tends to profit when the underlying stock price rises.

Bull Put Spread Strategy Characteristics

Let’s go over the strategy’s general characteristics:

Max Profit Potential: Net Credit Received x 100

Max Loss Potential: (Width of Put Strikes – Credit Received) x 100

Expiration Breakeven: Short Put Strike – Credit Received

Other Known Aliases: Short Put Spread, Put Credit Spread

To gain a better understanding of each concept, let’s walk through a trade example.

Profits/Losses at Expiration for a Bull Put Spread

In the following example, we’ll construct a bull put spread from the following option chain:

Strike Price

Put Price

To construct a bull put spread, we’ll have to simultaneously sell one of these puts and purchase the same number of puts at a lower strike price. In this case, we’ll sell the 90 put and buy the 85 put. Let’s also assume that the stock price is $90 when selling the spread.

Initial Stock Price: $90

Short Put Strike: $90

Long Put Strike: $85

Premium Collected for the 90 Put: $5.09

Premium Paid for the 85 Put: $2.84

In this example, selling the 90 put for $5.09 and buying the 85 put for $2.84 results in a net credit received of $2.25 (since $5.09 is collected, and $2.84 is paid). Additionally, the “spread width” is the difference between the long and short put strike, which is $5 in this case. Based on a net credit of $2.25 on a $5-wide bull put spread, here are the position’s characteristics:

Max Profit Potential: $2.25 Credit x 100 = $225

Max Loss Potential: ($5-Wide Strikes – $2.25 Credit) x 100 = $275

Expiration Breakeven Price: $90 Short Put Strike – $2.25 Credit = $87.75

Probability of Profit:

This bull put spread example has a probability of profit slightly greater than 50% because the breakeven price is less than the initial stock price, which means the stock price can fall slightly and the position can still profit. Additionally, the maximum loss potential is greater than the maximum profit potential.

Position After Expiration

If the stock price is below 85 at expiration, both puts expire in-the-money. At expiration, an in-the-money long put expires to -100 shares, and an in-the-money short put expires to +100 shares, which nets out to no stock position for the put spread seller. If the stock price is between 90 and 85 at expiration, only the short put expires in-the-money, resulting in a position of +100 shares for the short put spread trader.

The following visual demonstrates the potential profits and losses for this bull put spread at expiration:

Stock Price Above the Short Put Strike ($90):

Both the 85 and 90 put expire worthless. The profit on the short 90 put is $509, but the loss on the long 85 put is $284, resulting in a net profit of $225.

Stock Price Between the Short Put Strike ($90) and the Bull Put Spread’s Breakeven Price ($87.75):

The short 90 put expires with intrinsic value, but not more than the $2.25 credit received for the short put spread. Because of this, the bull put spread trader realizes a profit, but not the maximum profit since the position expires with some value.

Stock Price Between the Bull Put Spread’s Breakeven Price ($87.75) and the Long Put Strike ($85):

The short 90 put expires with more intrinsic value than the $2.25 credit the put spread trader collected when selling the spread. Because of this, the trader realizes a loss at expiration, but not the maximum loss.

Stock Price Below the Long Put Strike ($85):

The value of the $5-wide short put spread is $5. Since the spread was sold for $2.25, the trader realizes the maximum loss of $275.

Nice! You know how to determine the potential outcomes of a short put spread at expiration, but what about before expiration? To demonstrate how short put spreads perform before expiration, we’re going to look at a few examples of positions that recently traded in the market.

Bull Put Spread Trade Examples

In the following examples, we’ll compare changes in the stock price to a bull put spread on that stock. Note that we won’t discuss the specific stock the trade was on, as the same concepts regarding short put spreads apply to each stock. Additionally, each example represents one short put spread. The potential gains and losses scales proportionately to the number of put spreads traded.

Trade Example #1: Maximum Loss Bull Put Spread

The first example we’ll investigate is a situation where a trader sells an at-the-money put spread. An at-the-money bull put spread consists of selling an at-the-money put and buying an out-of-the-money put. When constructed properly, the breakeven price is slightly below the current stock price. Here’s the setup:

Initial Stock Price: $109.96

Strikes and Expiration: Short 110 put expiring in 46 days. Long 95 put expiring in 46 days.

Net Credit Received: $9.22 received for the 110 put – $3.67 paid for the 95 put = $5.55.

Breakeven Stock Price: $110 short put strike – $5.55 net credit received = $104.45.

Maximum Profit Potential: $5.55 net credit x 100 = $555.

Maximum Loss Potential: ($15-wide put strikes – $5.55 credit received) x 100 = $945.

Let’s see what happens!

As you can see here, the value of the put spread increases as the stock price falls, which is not good for a short put spread trader.

At expiration, both put strikes are in-the-money, which results in the maximum loss of $945 for the short put spread trader: ($5.55 sale price – $15 expiration price) x 100 = -$945 . Since a short put expires to +100 shares and a long put expires to -100 shares, no stock position is taken if the trader holds the in-the-money spread through expiration. However, it’s possible that the short put spread trader gets assigned on the short 110 put when it’s in-the-money with little extrinsic value.

Next, we’ll look at an example of a trade where the stock price is below the short put at expiration, but the position is still profitable.

Enjoying this analysis? Be sure to grab a copy of our free Trade Research PDF featuring historical trade results of the bull put spread on the S&P 500:

Trade Example #2: Partial Profit

In the next example, we’ll look at a situation where a trader sells an at-the-money put spread and does not realize the maximum profit potential.

Here’s the setup:

Initial Stock Price: $219.28

Strikes and Expiration: Short 220 put expiring in 49 days. Long 190 put expiring in 49 days.

Net Credit Received: $14.60 received for the 220 put – $4.60 paid for the 190 put = $10.

Breakeven Stock Price: $220 short put strike – $10 net credit received = $210.

Maximum Profit Potential: $10 net credit received x 100 = $1,000.

Maximum Loss Potential: ($30-wide put strikes – $10 credit received) x 100 = $2,000.

Let’s take a look:

As demonstrated here, the timing of the short put spread entry couldn’t have been worse. With just over 35 days to expiration, the put spread was trading for $20, which represents a $1,000 loss for a trader who sold the spread for $10.

However, since a short put spread has limited loss potential, let’s say the trader in this example held on to the position. Near expiration, the stock price rallied above the short put spread’s breakeven price of $210 and the put spread’s value fell. At expiration, the stock was trading for $217.11, which means the short 220 put was worth $2.89 and the 190 put was worthless. Since the trader sold the spread for $10, the expiration profit on the spread was $711: ($10 sale price – $2.89 expiration price) x 100 = +$711 .

Alright, you’ve seen short put spread examples that break even and realize the maximum loss. In the final example, we’ll investigate a trade that winds up with its greatest profit potential.

Trade Example #3: Maximum Profit Put Spread

In the final example, we’ll examine a bull put spread example that ends up with its maximum profit potential.

Here are the specifics of the final example:

Initial Stock Price: $716.03

Strikes and Expiration: Short 700 put expiring in 67 days. Long 640 put expiring in 67 days.

Net Credit Received: $30.20 received for the 700 put – $12.15 paid for the 640 put = $18.05.

Breakeven Stock Price: $700 short put strike – $18.05 net credit received = $681.95.

Maximum Profit Potential: $18.05 net credit received x 100 = $1,805.

Maximum Loss Potential: $60-wide put strikes – 18.05 net credit received = $4,195.

When the stock price rises significantly, the value of the put spread falls, which is great news for the put spread seller. In this example, there were plenty of opportunities for the trader to take profits before expiration. To close a bull put spread, the trader can simultaneously buy back the short put and sell the long put. As an example, let’s say the trader wanted to take profits when the spread’s price fell to $10. When the trader buys back the spread for $10, they lock in $805 in profits: ($18.05 initial spread sale price – $10.00 closing price) x 100 = +$805 .

At expiration, the stock is trading for over $725, and both the 700 and 640 put expire worthless. The resulting gain on the short 700 put is $3,020 and the loss on the long 640 put is $1,205. Therefore, the net profit on the position is $1,805 for the put spread seller, which is the position’s maximum profit potential.

Congratulations! You now know how short put spreads work as a trading strategy.

If you have any questions, comments, or feedback related to this post, feel free to contact me at any time.

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