Options Strategy – Bull Put Spread
A Bull Put Spread, also known as a Short Put Spread, is an options trading strategy used when a trader expects a moderate rise or stable movement in the price of the underlying asset. This strategy involves selling a put option at a higher strike price while simultaneously buying another put option at a lower strike price, both with the same expiration date. The goal is to generate a net credit (premium received minus premium paid) while limiting potential losses.
- Market Direction: Bullish
- Difficulty: Intermediate
How It Works
- Sell a Put Option: The trader sells a put option with a higher strike price.
- Buy a Put Option: The trader buys a put option with a lower strike price.
- Market Movement: The trader benefits if the price of the underlying asset remains above the higher strike price.
- Profit and Loss: The maximum profit is the net credit received, and the maximum loss is the difference between the strike prices minus the net credit.
Example of a Bull Put Spread Strategy
Let’s say you expect the stock price of Company XYZ, currently trading at $50, to rise or stay above $45. You decide to implement a Bull Put Spread with the following specifics:
- Sell Put Option: Strike Price $45, Premium Received $3 per share
- Buy Put Option: Strike Price $40, Premium Paid $1 per share
- Expiration Date: 1 month from now
You trade one put option contract, which represents 100 shares, so your net credit is:
100 shares×($3−$1)=$200
Scenarios
- Stock Price Remains Above Higher Strike Price ($45)
If, at expiration, the stock price remains at $50 or rises:- Both put options expire worthless.
- Keep the Net Credit: You keep the $200 net credit.
- Net Profit: $200 (net credit received).
- Stock Price Falls Below Lower Strike Price ($40)
If, at expiration, the stock price falls to $35:- The sold put option is exercised.
- Loss on Sold Put: $45 (strike price) – $35 (market price) = $10 per share.
- Gain on Bought Put: $40 (strike price) – $35 (market price) = $5 per share.
- Net Loss: $10 – $5 = $5 per share.
- Total Loss: $5 x 100 = $500.
- Adjusted Loss: $500 – $200 (net credit) = $300.
- Stock Price Between $45 and $40
If, at expiration, the stock price is between $45 and $40:- The sold put option is exercised.
- Gain on Sold Put: $45 (strike price) – $50 (market price) = $5 per share.
- Loss on Bought Put: $40 (strike price) – $45 (market price) = $5 per share.
- Break-even Point: The trader neither gains nor loses additional money beyond the initial net credit.
Benefits of Bull Put Spread
- Income Generation: Provides income from the net credit received.
- Limited Risk: The potential loss is capped by the lower strike price of the bought put option.
- Bullish to Neutral Outlook: Profits if the stock price rises or remains steady.
Risks of Bull Put Spread
- Limited Profit: The maximum profit is limited to the net credit received.
- Potential Loss: Losses can occur if the stock price falls below the lower strike price.
The Bull Put Spread strategy is an effective way to capitalize on a bullish or neutral outlook with limited risk and defined potential profit.
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