What is a Bear Put Spread? How do you buy put options on a discount with a bear put spread?
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Bear Put Spread - Introduction
A Bear Put Spread is a bearish option strategy
that profits when the
underlying stock falls. This is also one of the best bearish debit spread options strategy, capable of optimizing your potential profits for when you are certain that the price of the underlying stock
is going to go down to a definite price and not beyond.
A Bear Put Spread
is the reverse of a Bull Call Spread
and works the same way in the opposite direction.
The Bear Put Spread involves simultaneously buying to open and
selling to open options of the same expiration month
, making it a Vertical Spread
because you need to pay money to put on this position, resulting
in a net debit, this is also a Debit Spread
A Bear Put Spread is also a technique to buy put options
discount. Because you sell to open
an Out of the Money
(OTM) put option in this option strategy, it effectively reduces your investment on your In the Money
At The Money
(ATM) Put options. This reduces upfront payment and therefore the risk of the position,
making it an ideal option trading strategy for beginners who wish to profit from a down market.
Bear Put Spread - Classification
: Moderately Bearish
: Vertical Spread
Debit or Credit
When To Use Bear Put Spread?
One should use a Bear Put Spread when one is confident in a moderate drop in the price of the underlying asset.
How To Use Bear Put Spread?
Establishing a Bear Put Spread involves the purchase of an At The Money or In The Money put option on the underlying asset while simultaneously writing (sell to open) an
Out of the Money put option on the same underlying asset with the same expiration month. Ideally, you should be writing the out of the money put options at the strike price at which
you think the stock is going to drop down to but not further than.
Buy ATM Put + Sell OTM Put
Bear Put Spread Example
Example : Assuming QQQQ at $44. Buy To Open 10 QQQQ Jan44Put for $1.05, Sell To Open 10 QQQQ Jan43Put for $0.50
Net Debit = $1.05 - $0.50 = $0.55
If you expect QQQQ to go down to near $42 by expiration, you will Sell to Open QQQQ Jan42Put instead.
The profitability of a bear put spread can be enhanced or better guaranteed by legging
into the position properly.
Trading Level Required For Bear Put Spread
A Level 3 options trading account that allows the execution of debit spreads is needed for the Bear Put Spread. Read more about Options Account Trading Levels
Profit Potential of Bear Put Spread :
The Bear Put Spread profits when the stock goes down. When that happens, the long
put option goes up in price along with the underlying asset while the
put options continue to decay in premium
The maximum profit potential of a bear put spread is when the price of the underlying instrument drops down to the strike price
of the out of the money short options and beyond where any gain in the long put options is matched exactly by a loss in the short put options.
Profit Calculation of Bear Put Spread:
Maximum Return = (Difference in strikes - Net Debit) ÷ Net Debit
Following up from the above example:
Buy to open 10 QQQQ Jan44Put for $1.05 per contract and sell to open 10 QQQQ Jan43Put for $0.60 per contract
Max. Return = (44 - 43 - (1.05 - 0.60)) ÷ (1.05 - 0.60) = 0.55 ÷ 0.45 = 122%
Max. Risk = Net Debit = $1.05 - $0.60 = $0.45, if QQQQ is > $44
Break Even = Higher Strike - Net Debit = $44 - $0.45 = $43.55
Risk / Reward of Bear Put Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
Net Debit Paid
Break Even Point of Bear Put Spread:
BEP: Strike Price
of Long Put Option - Net Debit Paid
Advantages of Bear Put Spread :
Loss is limited if the underlying asset rises instead of fall.
If the underlying asset fails to fall beyond the strike price of the out of the money short call option, the profit yield will be
greater than just buying put options.
It is also a way of buying put options at a discount by selling the out of the money put option at a strike price beyond that which
the underlying asset is expected to fall.
Disadvantages of Bear Put Spread :
There will be more commissions involved than simply buying put options.
There will be no more profits possible if the underlying asset falls beyond the strike price of the out of the money put option so profit is limited.
Adjustments for Bear Put Spread Before Expiration :
1. If the underlying asset is expected to continue to fall strongly beyond the strike price of the short put option,
one could buy to close the out of the money short put option and then sell to open a further out of the money put option in its place.
2. If the underlying asset is expected to continue to fall strongly beyond the strike price of the short put option,
one could also choose to buy to close the out of the money short put option and then simply allow the long put option to continue to gain in value.
3. If the underlying stock is expected to pull up upon reaching the strike price of the short put options, you could close the profitable long put options when the strike price of the short put options are reached and then buy out of the money put options in order to transform the position into a Bull Put Spread. This transformation can be automatically performed without monitoring using a Contingent Order.
Bear Put Spread Questions:
:: What To Do When Short Leg of Put Spread is Assigned?