Both options are in the same expiration cycle. Let's go over the strategy's general characteristics: Resulting Position After Expiration: Because of this, the put spread buyer is profitable at expiration. You know the basics of the bear put spread strategy! In the next section, we'll look at real trade examples to show you how the strategy performs over time.
To visualize the performance of various long put spread positions, let's look at a few real examples. Before we start, it's important to note that we won't specify the stock the trade was on, as the concepts in each case are transferable to put spreads on other stocks in the market. In this example, the put spread is entirely out-of-the-money when entering the trade.
Let's see what happens! As we can see here, the put spread's value increased as the stock price fell. Additionally, even when the stock price falls, the long put spread trader may still lose money due to time decay if the move doesn't happen quickly.
Next, we'll look at a profitable long put spread position. In the previous example, we examined a gradual stock price decrease after buying an out-of-the-money put spread.
In this example, an in-the-money put is purchased while an out-of-the-money put is sold. Let's take a look at the spread's performance! In this particular case, the spread had profits almost the entire period, resulting in opportunities for the long put spread trader to take profits early.
With all risk and little reward, the logical decision would be to close the spread early. At expiration, both puts were in-the-money. However, there is a possibility that the long put spread trader is assigned early on the short put, as the put was deep-in-the-money for a majority of the period. In the final example, we'll look at an in-the-money long put spread example. In the final example, we'll examine an in-the-money put spread as the stock price increases steadily.
In this case, the put is purchased while the put is sold. This particular put spread is entirely in-the-money since the stock price is below both of the put strikes at trade entry. Additionally, the breakeven price is higher than the stock price, which means the share price can rise and the long put spread position can still profit. Let's see what happens with this trade! As illustrated in this example, the stock price began to rise right after the long put spread position was initiated.
Because of this, the put spread's value fell. In addition to the stock price rising, time decay also played a part in the collapse of the put spread's value.
When the stock price is above the spread's breakeven price, the price of the spread will decay towards an unprofitable price as expiration approaches. The net loss in this case is equal to: Lastly, if the trader held the spread through expiration, they would end up with shares of stock because the long put expired in-the-money.
To avoid a resulting stock position after expiration, the long put spread trader would need to sell the put before expiration. When closing the long option of a spread, it's also advisable to close the short option as well, as not closing the short option leaves the trader with a highly risky position. Be sure to read the summary of key concepts below. Here are the essential points to remember about buying a put spread: The position is constructed by purchasing a put, while also selling the same number of puts at a lower strike price.
Buying a put spread can have a low or high probability of profit. When the profit potential is less than the loss potential typical for in-the-money put spreads , the probability of profit is high, in theory. Conversely, when the loss potential is lower than the profit potential typical for out-of-the-money put spreads , the probability of profit is low, in theory. If only the long put is in-the-money at expiration, the trader will end up with shares of stock if the option is held through expiration.
If the entire put spread is in-the-money at expiration, the trader will not end up with a stock position after expiration. However, it is possible that the long put spread trader is assigned early on the short put when if it is in-the-money. Summary of Main Concepts. Estimated Probability of Profit:More...