Bear Put Spread Introduction
The Bear Put Spread strategy requires the investor to buy In-The-Money (higher) strike price put options while simultaneously selling Out-of-The-Money (lower) strike price put options on the same underlying stock. A Bear Put Spread strategy is profitable when the stock price moves below the break-even point: upper strike price minus net debit. A characteristic of the vertical Bear Put Spread is the put options are sold and bought on the same underlying stock with the same expiration date (the reason why it is referred to as a vertical spread). The benefit of the Bear Put Spread strategy is that risk never exceeds the net investment of buying and selling put options simultaneously. This strategy is considered moderately bearish because the investor is using the sale of a put to reduce his or her risk while still positioning for a decent profit should the stock price move below the lower put option strike price. The maximum loss potential is reached if the stock moves above the in-the-money (higher) put option strike price.
Bear Put Spread Introduction
The Bear Put Spread is one of the most popular bearish strategy. The strategy profits when the underlying stock falls. It is a technique used to buy puts at a discount. It is a good position to be in if you want to be in the stock but are unsure of the general bearish expectations.
Strategy Summary: Buy put option with a higher strike and sell another put option with a lower strike, producing a net debit. It is more effective when the market outlook is moderately bearish, or when the volatility outlook is steady to increasing.
More Detailed Explanation: The Bear Put Spread strategy requires the investor to buy In-The-Money (higher) strike price put options while simultaneously selling Out-of-The-Money (lower) strike price put options on the same underlying stock. A Bear Put Spread strategy is profitable when the stock price moves below the break-even point: upper strike price minus net debit. A characteristic of the vertical Bear Put Spread is the put options are sold and bought on the same underlying stock with the same expiration date (the reason why it is referred to as a vertical spread). The benefit of the Bear Put Spread strategy is that risk never exceeds the net investment of buying and selling put options simultaneously. This strategy is considered moderately bearish because the investor is using the sale of a put to reduce his or her risk while still positioning for a decent profit should the stock price move below the lower put option strike price. The maximum loss potential is reached if the stock moves above the in-the-money (higher) put option strike price.
Definition - Debit Spread Position
As previously mentioned, a Bear Put Spread is the purchase of an in-the-money (higher) put option while simultaneously selling an out-of-the money (lower) put option on the same underlying stock. That is, there is one strike price above the stock price and one below. Because the sale of the out-of-the-money (lower) strike price brings in less cash flow than the cost of purchasing an in-the-money (higher) strike price put option, it is considered a "Debit Spread." To emphasize this point, if a spread position takes in more through the sale of one put option position than it costs to purchase the other put option position, it is a "Credit Spread." If the opposite were true (the put buy position costs more than the sale of the other put position), it is a "Debit Spread." A Debit Spread position occurs with Bull Call Spreads and Bear Put Spreads. A Bear Put Spread position is always considered a debit spread because the purchase of the in-the-money (higher) put strike price costs more than is received for selling the out-of-the-money (lower) put option.
Investor Sentiment:
Moderate Bearish Strategy (Small Debit Spread): Is considered a bearish strategy because you profit if the underlying stock price decreases. Bear Put spreads are typically used when a trader anticipates at least a moderate drop in the underlying asset.
Profit Potential:
This strategy requires the investor to buy an in-the-money put option and sell an out-of-the-money put option on the same stock with the same expiration date. This is also known as a vertical bear put spread. If the stock price closes below the out-of-the-money (lower) put option strike price on the expiration date, the investor reaches maximum profits.
Risks:
If the stock price increases above the in-the-money (higher) put option strike price at the expiration date, the investor has a maximum loss potential of the net debit.
Advantages:
• Easy to implement.
• There can be little margin deposit or margin calls required.
• Requires less capital than out-right purchases of a put option.
• You know the most you can gain or lose from the spread.
Drawbacks:
• The spread strategy only provides limited gain.
• Bear Put Spread offers only limited downside price protection. It protects only prices down to the strike price of the put option sold.
• Check broker, you probably will be charged two commissions.
• The put option sold can be exercised by the buyer of the option at any time.
Bear Put Spread strategy can provide a lower risk than strictly buying a put option, but it also limits the profit potential. Bear Put Spreads can be used as a hedge against a falling market. However, if the market falls below the strike price of the sold put option, the cash price plus the gain from the spread will decrease. The maximum profit potential only happens if the stock decreases below the out-of-the-money (lower) put option strike price. Similar to a Bull Call Spread, this strategy is a debit spread position. That is, the amount of the sale of the put option position brings in less than is needed to purchase the put option position.
Other Considerations:
If the stock falls sharply unexpectedly, some will exit the strategy once the lower strike price is reached. They do this because the time decay benefits the spread near the lower strike price; however a trader becomes concerned with avoiding exercise on the short leg of the spread. Traders may unwind the spread if the stock price rises suddenly to avoid the taken put losing too much of the time value.
One more thing: Traders do not leg into this strategy but rather trade both options at the same time.
Profit / Loss Summary:
Net Debit = Money received from selling out-of-the-money (OTM) put options - Money paid for buying in-the-money (ITM) put options
Maximum Profit Potential = Difference Between Strike Prices - Net Debit
Maximum Loss Potential = Net Debit