A bull put spread is a variation of the popular put writing strategy, in which an options investor writes a put on a stock to collect premium income and perhaps buy the stock at a bargain price. A major risk of put writing is that the investor is obligated to buy the stock at the put strike price , even if the stock falls well below the strike price, resulting in the investor facing an instant and sizable loss. A bull put spread mitigates this inherent risk of put writing through the concurrent purchase of a put at a lower price, which reduces the net premium received but also lowers the risk of the short put position.
A bull put spread involves writing or short selling a put option, and simultaneously purchasing another put option on the same underlying asset with the same expiration date but a lower strike price. The premium received for the short put leg of a bull put spread is always more than the amount paid for the long put, which means that initiating this strategy involves receiving an upfront payment or credit.
A bull put spread is, therefore, also known as a credit put spread or a short put spread. A hypothetical stock, Bulldozers Inc. Consider the possible scenarios a month from now in the final minutes of trading on the option expiration date:. A scenario where the stock trades above the strike price of the short put leg is the best possible scenario for a bull put spread.
The trader therefore has two choices: The trader therefore breaks even on the trade but is out of pocket to the extent of the commissions paid. The maximum loss occurs when the stock trades below the strike price of the long put. Conversely, the maximum gain occurs when the stock trades above the strike price of the short put.
The bull put spread is a suitable option strategy for generating premium income or buying stocks at effective below-market prices. However, while this strategy has limited risk, its potential for gains is also limited, which may restrict its appeal to relatively sophisticated investors and traders.
Dictionary Term Of The Day. A reduction in the ownership percentage of a share of stock caused by the issuance Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance.
Become a day trader. Bull Put Spread A bull put spread involves writing or short selling a put option, and simultaneously purchasing another put option on the same underlying asset with the same expiration date but a lower strike price. Profiting from a Bull Put Spread A bull put spread should be considered in the following situations: To earn premium income: This strategy is ideal when the trader or investor wishes to earn premium income, but with a lower degree of risk than through writing puts only.
To buy a stock at a lower price: A bull put spread is a good way to buy a desired stock at an effective price that is lower than its current market price. To capitalize on sideways to marginally higher markets: Put writing and bull put spreads are optimal strategies for markets and stocks that are trading sideways to marginally higher. Other bullish strategies, such as buying calls or initiating bull call spreads, would not work as well in such markets.
To generate income in choppy markets: Put writing is risky business when markets slide because of the greater risk of being assigned stocks at needlessly high prices. A bull put spread may enable puts to be written even in such markets by capping downside risk. Example A hypothetical stock, Bulldozers Inc. Consider the possible scenarios a month from now in the final minutes of trading on the option expiration date: The former course of action is preferable, since the latter would incur additional commissions.
The loss on this position is therefore: Calculations To recap, these are the key calculations associated with a bull put spread: Advantages of a Bull Put Spread Risk is limited to the difference between the strike prices of the short put and long put. This means that there is little risk of the position incurring large losses, as would be the case with puts written on a sliding stock or market.
The bull put spread takes advantage of time decay, which is a very potent factor in option strategy. Since most options either expire or go unexercised, the odds are on the side of a put writer or bull put spread originator.
A relatively conservative trader may opt for a narrow spread where the put strike prices are not very far apart, as this will reduce the maximum risk as well as the maximum potential gain of the position. An aggressive trader may prefer a wider spread to maximize gains even if it means a bigger loss should the stock decline. Since it is a spread strategy , a bull put spread will have lower margin requirements compared to put writes.
Risks Gains are limited in this option strategy and may not be enough to justify the risk of loss if the strategy does not work out. There is a significant risk of assignment on the short put leg before expiration, especially if the stock slides.
This may result in the trader being forced to pay a price well above the current market price for a stock. This risk is greater if the difference is substantial between the strike prices of the short put and long put in the bull put spread.
As noted earlier, a bull put spread works best in markets trading sideways to marginally higher, which means that the range of optimal market conditions for this strategy is quite limited. If markets surge, the trader would be better off buying calls or using a bull call spread; if markets plunge, the bull put spread strategy will generally be unprofitable.
The Bottom Line The bull put spread is a suitable option strategy for generating premium income or buying stocks at effective below-market prices. A reduction in the ownership percentage of a share of stock caused by the issuance of new stock.
Dilution can also occur A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. Passive investing is an investment strategy that limits buying and selling actions. Passive investors will purchase investments How much a fixed asset is worth at the end of its lease, or at the end of its useful life.
If you lease a car for three years, No thanks, I prefer not making money. Get Free Newsletters Newsletters.More...