Put Time Spread

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Put Time Spread - Introduction



The Put Time Spread, being one of the three popular forms of Time Spreads (the other 2 being the Call Time Spread and Ratio Time Spread), is a neutral options trading strategy that profits when the underlying asset stays stagnant. Unlike the Call Time Spread, Put Time Spreads uses put options instead of call options.

Just like the Call Time Spread, the Put Time Spread profits primarily from the difference in rate of time decay between the near term short options and the long term LEAPs. This tutorial shall teach you what Put Time Spreads are, when to use Put Time Spreads and how to use Put Time Spreads.

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Put Time Spread is a form of debit spread Because you need to buy LEAPs which are more expensive than the short term options that you will write.

There are two types of Put Time Spreads. One way is to buy and write options of different expiration months and different strike prices. In this case, it is classified as a Diagonal Spread. The other way is to buy and write options of different expiration months but at the same strike price. In this case, it is classified as a Horizontal Spread. We will be exploring both versions of the Put Time Spread here. I call them the Diagonal Put Time Spread and the Horizontal Put Time Spread.

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When To Use Put Time Spread?


Put Time Spread is useful when you wish to profit from a stock that is expected to stay stagnant or within a tight range and still have a long term put position for if the stock should breakout to downside.



How To Use Put Time Spread?


Diagonal Put Time Spread


In this version of the Put Time Spread, all you have to do is to purchase an In the Money (ITM) LEAPS Put options and then sell At the Money (ATM) or Out of the Money (OTM) near term Puts against the LEAPS.

Diagonal Put Time Spread Example:
Example : Assuming QQQQ trading at $45 now. Buy To Open 10 contracts of QQQQ Jan 2008 $46 Put options at $5.70.
Sell To Open 10 contracts of QQQQ Jan 2007 $45 Put at $0.75.


Please read the full tutorial on Diagonal Put Time Spread.

Horizontal Put Time Spread


In this version of the Put Time Spread, At The Money (ATM) LEAPS Put options are bought and then ATM near term Puts are written.

Horizontal Put Time Spread
Example : Assuming QQQQ trading at $45 now. Buy To Open 10 contracts of QQQQ Jan 2008 $45 Put options at $4.70.
Sell To Open 10 contracts of QQQQ Jan 2007 $45 Put at $0.75.


Please read the full tutorial on Horizontal Put Time Spread.



Profit Potential of Put Time Spread :


Both the Diagonal Put Time Spread and the Horizontal Put Time Spread makes their maximum profit when the stock closes at the strike price of the short put options during expiration of the short put options.





Profit Calculation of Put Time Spread:


The value of a Put Time Spread during expiration of the short put options can only be arrived at using an options pricing model such as the Black-Scholes Model because the expiration value of the long term put options can only be arrived at using such a model.



Risk / Reward of Put Time Spread:



Upside Maximum Profit: Limited

Maximum Loss: Limited
(limited to net debit paid)



Break Even Point of Put Time Spread:


The breakeven point of a Put Time Spread is the point below which the position will start to lose money if the underlying stock rises or falls strongly and can only be calculated using the Black-Scholes model.



Advantages Of Put Time Spread:



  • Able to profit even if underlying asset stays stagnant.

  • If an investor purchases the Long Put several months out in time, near term Puts can be written several times before the Long Put expiration. Therefore, the cost of the Long Put can be greatly reduced with many writes.

  • Losses are limited to the net debit.



    Disadvantages Of Put Time Spread:



  • Profits are limited.

  • Losses can be sustained if the short Put options are assigned when the underlying asset drops quickly.



    Alternate Actions for Put Time Spreads Before Expiration :



    1. If you wish to profit from a drop in the underlying asset, you could buy back the short Put options before it expires and allow the LEAPS Put Options to continue its profit run.


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