Bull Put Spread

 

Description

The Bull Put spread is an intermediate strategy that can be profitable for stocks that are either range bound or rising. The strategy is to buy a put and at the same time sell a put with a higher strike price.

Both put strikes should be lower than the current stock price so as to ensure a profit even if the stock does not move. The lower strike put that you buy is further out-of-the-money than the higher strike put that you sell. Therefore you receive a net credit because you buy a cheaper option than the one you sell, which highlights that options are cheaper the further out-of-the-money you go.

If the stock rises, both puts will expire worthless, and you simply retain the net credit. If the stock falls, then your break even is the higher strike less the net credit you receive. Provided the stock remains above that level, then you will make a profit. Otherwise you could experience a loss. Your maximum loss is the difference in strikes less the net credit received.

Market Opinion

Bullish or neutral to bullish.

P/L Profile

 

When to Use

 

When you are looking for income and have a bullish outlook on a stock, while limiting downside risk.

 

Example

 

An investor believes that stock XXXX, trading at $20, is going to rise soon, and enters into a bull put spread. The investor earns a net credit. The price of the stock rises, and on expiration of the options (which expire worthless) the investor keeps the credit, which is the maximum amount of profit possible.

 

XXXX is trading at $20.00 on April 15, 2011.

Buy the May 2011 20 strike put for $0.50.

Sell the May 2011 25 strike put for $1.00.

 

Net credit=premium sold minus premium bought ($1.00 - 0.50 = 0.50)

 

Benefit

 

This is a short term strategy that does not require movement of the stock. It also has capped downside protection.

 

Risk vs. Reward

 

Reward is the credit/income from sold puts minus bought puts. The risk is the difference between the strike prices minus your net credit.

 

Net Upside

 

Net credit received.

 

Net Downside

 

Difference in strikes minus net credit.

 

Break Even Point

 

Higher strike minus net credit.

 

Volatility

 

Time Decay

 

Positive effect when this position is profitable and negative when it is in a loss position. The nearer you get to expiration, the higher your loss.

 

Alternatives Before Expiration

 

An investor may wish to unravel this position partially, leg by leg, leaving one leg exposed in an attempt to make a profit.

 

Alternatives After Expiration

Close the position. Buy back the puts sold and sell the puts bought.