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A bull put spread consists of one short put with a higher strike price and one long put with a lower strike price. Both puts have the same underlying stock and the same expiration date. A bull put spread is established for a net credit or net amount received and profits from either a rising stock price or from time erosion or from both.
Potential profit is limited to the net premium received less commissions and potential loss is limited if the stock price falls below the strike price of the long put. Potential profit is limited to the net premium received less commissions, and this profit is realized if the stock price is at or above the strike price of the short put higher strike at expiration and both puts expire worthless.
The maximum risk is equal to the difference between the strike prices minus the net credit received including commissions. In the example above, the difference between the strike prices is 5. The maximum risk, therefore, is 3. This maximum risk is realized if the stock price is at or below the strike price of the long put at expiration. Short puts are generally assigned at expiration when the stock price is below the strike price. However, there is a possibility of early assignment.
A bull put spread earns the maximum profit when the price of the underlying stock is above the strike price of the short put higher strike price at expiration. A bull put spread is the strategy of choice when the forecast is for neutral to rising prices and there is a desire to limit risk.
A bull put spread benefits when the underlying price rises and is hurt when it falls. Also, because a bull put spread consists of one short put and one long put, the net delta changes very little as the stock price changes and time to expiration is unchanged.
Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to expiration remain constant. Since a bull put spread consists of one short put and one long put, the price of a bull put spread changes very little when volatility changes and other factors remain constant.
This is known as time erosion. Since a bull put spread consists of one short put and one long put, the sensitivity to time erosion depends on the relationship of the stock price to the strike prices of the spread. This happens because the short put is closest to the money and erodes faster than the long put. This happens because the long put is now closer to the money and erodes faster than the short put. If the stock price is half-way between the strike prices, then time erosion has little effect on the price of a bull put spread, because both the short put and the long put erode at approximately the same rate.
Stock options in the United States can be exercised on any business day, and holders of a short stock option position have no control over when they will be required to fulfill the obligation. Therefore, the risk of early assignment is a real risk that must be considered when entering into positions involving short options. While the long put lower strike in a bull put spread has no risk of early assignment, the short put higher strike does have such risk.
Early assignment of stock options is generally related to dividends, and short puts that are assigned early are generally assigned on the ex-dividend date. In-the-money puts whose time value is less than the dividend have a high likelihood of being assigned.
Therefore, if the stock price is below the strike price of the short put in a bull put spread the higher strike , an assessment must be made if early assignment is likely. If assignment is deemed likely and if a long stock position is not wanted, then appropriate action must be taken. Before assignment occurs, the risk of assignment can be eliminated in two ways. First, the entire spread can be closed by buying the short put to close and selling the long put to close. Alternatively, the short put can be purchased to close and the long put open can be kept open.
If early assignment of a short put does occur, stock is purchased. If a long stock position is not wanted, the stock can be sold either by selling it in the marketplace or by exercising the long put.
Note, however, that whichever method is chosen, the date of the stock sale will be one day later than the date of the stock purchase.
This difference will result in additional fees, including interest charges and commissions. Assignment of a short put might also trigger a margin call if there is not sufficient account equity to support the stock position.
There are three possible outcomes at expiration. The stock price can be at or above the higher strike price, below the higher strike price but not below the lower strike price or below the lower strike price.
If the stock price is at or above the higher strike price, then both puts in a bull put spread expire worthless and no stock position is created. If the stock price is below the higher strike price but not below the lower strike price, then the short put is assigned and a long stock position is created. If the stock price is below the lower strike price, then the short put is assigned and the long put is exercised.
The result is that stock is purchased at the higher strike price and sold at the lower strike price and the result is no stock position. A bear put spread consists of one long put with a higher strike price and one short put with a lower strike price. A bull call spread consists of one long call with a lower strike price and one short call with a higher strike price.
Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.
Charts, screenshots, company stock symbols and examples contained in this module are for illustrative purposes only. Skip to Main Content. Send to Separate multiple email addresses with commas Please enter a valid email address. Your email address Please enter a valid email address. Short 1 Put at 3. Related Strategies Bear put spread A bear put spread consists of one long put with a higher strike price and one short put with a lower strike price.
Bull call spread A bull call spread consists of one long call with a lower strike price and one short call with a higher strike price. Please enter a valid ZIP code.More...