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Bull Put Spread - Introduction
A Bull Put Spread is a bullish option strategy that works in the same way a
Bull Call Spread does,
profiting when the underlying stock rises.
The Bull Put Spread is simply a naked Put write
which minimizes margin requirement and limits potential loss by purchasing a lower strike price put option.
Because the Bull Put Spread is a credit spread,
you also make money if the underlying asset stays stagnant through the
decay and expiration
of the more expensive short put options. The Bull Call Spread, on the other hand, would not be able to profit if the stock did not move down beyond its breakeven point.
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When To Use Bull Put Spread?
One should use a bull put spread when one is moderately confident of a rise in the underlying asset and wants some protection and profit
should the underlying asset remains stagnant.
How To Use Bull Put Spread?
Establishing a Bull Put Spread involves the purchase of an At The Money or Out of The Money put option on the underlying asset while simultaneously writing (sell to open) an
In the Money or At The Money put option on the same underlying asset with the same expiration month.
Example 1 : Assuming QQQQ at $44. Buy To Open 10 QQQQ Jan44Put, Sell To Open 10 QQQQ Jan45Put
If you expect QQQQ to go up beyond $46 by expiration, you will Sell to Open QQQQ Jan46Put instead.
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Which strike prices to choose also depends on your desired effect. If the Bull Put Spread is established by selling ATM Put option and buying OTM
Put options, the position needs only stay stagnant or rise to result in a profit, hence a higher profit probability.
The drawback is that this method decreases the maximum profit
potential of the Bull Put Spread. Again, like all option trading strategies, there is a trade-off between maximum profit and profit probability.
Example 2 : Assuming QQQQ at $44. Buy To Open 10 QQQQ Jan43Put, Sell To Open 10 QQQQ Jan44Put
A Bull Put Spread results in maximum profit when the underlying stock closes above the strike price of the short put options. In this case,
the strike price of the short put options is directly on the prevailing stock price, allowing it to reach maximum profit even if the stock remains
stagnant.
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Profit Potential of Bull Put Spread :
The Bull Put Spread profits in 2 ways. Firstly, if the stock goes up, the short put option goes down in price and eventually expire out of the money when
the underlying asset rises beyond the strike price of the short put option (example 1 above).
Secondly, while the underlying asset stays stagnant, the premium on the more expensive short put
option will continue to decay until it has no value thereby allowing one to pocket the price of the short option (example 2 above).
Being a credit spread, the maximum profit potential of a Bull Put Spread is the net credit gained when the position is put on.
This occurs when the short put option expires out of the money.
Profit Calculation of Bull Put Spread:
Maximum Return = Net Credit
Following up from the above example 1:
Buy to open 10 QQQQ Jan44Put for $1.05 per contract and sell to open 10 QQQQ Jan45call for $1.85 per contract
Max. Return = $1.85 - $1.05 = $0.80 when QQQQ closes above $45
Max. Risk = Difference in Strike - Net Credit = ($45 - $44) - $0.80 = $0.20 when QQQQ closes below $44
Break Even = higher Strike - Net credit = $45 - $0.80 = $44.20
Following up from the above example 2:
Buy to open 10 QQQQ Jan43Put for $0.60 per contract and sell to open 10 QQQQ Jan44Put for $1.05 per contract
Max. Return = $1.05 - $0.60 = $0.45 when QQQQ closes above $44
Max. Risk = Difference in strike - net credit = ($45 - $44) - $0.45 = $0.55 when QQQQ closes below $43
Break Even = Higher Strike - Net credit = $44 - $0.45 = $43.55
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Notice that using higher strike prices for a Bull Put Spread results in a lower maximum profit but a much more favorable profit
probability and a maximum loss that occurs at a much lower point.
Risk / Reward of Bull Put Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
Break Even Point of Bull Put Spread:
BEP: higher Strike - Net credit
Advantages Of Bull Put Spread :
Loss is limited if the underlying financial instrument falls instead of rise.
If the underlying instrument fails to rise beyond the strike price of the out of the money short put option, the profit yield will be
greater than just buying call options.
Able to profit even when the underlying asset remains completely stagnant.
Disadvantages Of Bull Put Spread :
There will be more commissions involved than simply buying call options or just selling naked put options.
Lower risk than simply writing naked put options as maximum downside is limited by the long ATM/OTM put option.
There will be no more profits possible if the underlying asset rises beyond the strike price of the short put option.
Because it is a credit spread, there is a margin requirement in order to put on the position.
As long as the short put options remain in the money, there is a possibility of it being assigned. You may then have
to purchase the underlying stock to meet the short put obligation.
Alternate Actions Before Expiration :
1. If your moderately bullish opinion on the underlying asset turns out to be wrong and the underlying asset continues to rise strongly
beyond the strike price of the short put option,
one could sell the out of the money long put option in order to preserve some equity from the long put option and allow the short put options to expire.
Doing so will transform the position
to a naked put position with unlimited downside risk. One could also close out the position after the underlying asset exceeds the strike price of
the short put option and then switch to an option strategy with unlimited profit potential, like a long call buy or a long straddle.
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