The Bull Put Spread is a vertical spread strategy in which the investor sells a higher strike price put option, represented by point B, and buys a lower strike price put option, represented by point A, both inside the same expiration month.
The investor will receive a premium or credit, as the higher strike price put will have more value than the lower strike price put.
If the investor believes the market will remain flat or rise, they will employ this method. The lower put option is used as a hedge in case the market trades lower, allowing the investor to limit their maximum loss.
Profit/Loss
- The maximum profit an investor can expect from this trade is the credit they received. The investor will profit the most if the stock closes above the higher strike price at expiration.
- The maximum loss can be computed by subtracting the strike prices from the premium received. This is achieved when the strike price at expiration exceeds the aforementioned strike price.
Breakeven
A bull put spread’s breakeven point is the higher strike price minus the premium received.
Breakeven = short put strike – premium received
Example
A 70-75 bull put spread worth Rs.2 would involve selling a 75-strike price put and purchasing a 70-strike price put. If the stock remained above the 75-strike price, the maximum win would be Rs.2.
Having a Rs.5 strike width (70-75), reflecting the maximum loss if the deal ends below both strike prices, less the premium earned to enter the trade, in our example Rs.2, leaving the investor with a maximum loss of Rs.3.
If the put spread is out of the money, time decay works in the investor’s favour since they want the deal to expire so they may keep the full premium received. If the vertical has both strikes in the money, time will work against the investor since they will want this trade to continue, providing them more time for the stock to grow in price.
Conclusion
This is a wonderful strategy to adopt if an investor believes a stock is going up but is unsure of the timing or wants to provide himself a buffer in case the market trades sideways or slightly lower.
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