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.