A Bull Put spread is and options strategy where a trader buys a lower strike price put and simultaneously sells another put with a higher strike for the same expiration month. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts.
A Bull Put spread is used when a market can be volatile, where the investor anticipates the market still has bullishness to it, or where the expectations are a market should rise more than fall. The spread is like writing a put with protection in place against a collapse in that market.
The Bull Put spread is a strategy similar to the Bull Call spread but the Bull Put spread there is a premium or credit that goes into your account when you establish the position.
The bull call spread can be considered a doubly hedged strategy. The price paid for the call with the lower strike price is partially offset by the premium received from writing the call with a higher strike price. The investor's investment in the long call, and the risk of losing the entire premium paid for it, is reduced or hedged.
The goal is to keep the premium. The basic idea is you want the asset to remain bullish and the sell puts to expire worthless. Because the Bull Put Spread is a “credit spread” you make money if the underlying asset stays stagnant through the decay part and the expiration of the more expensive short put options.
A Bull Put spread is similar to a Naked Put with the exception that you minimize your margin requirement and you limit your downside risk by purchasing a lower put strike price. Many traders like the idea of starting a trade with a profit. In a Naked Put or a Bull Put spread this happens when you get a credit to your account. With a Naked Put the trade can start to move against you and you cannot limit your downside risk. With a Bull Put spread you can essentially limit that portion of risk.
When compared to most options spreads the Bull Put spread is a lower risk but also lower reward potential strategy. While it ends up limiting a loss it also limits gains. The Bull Put spread strategy is a cheaper way of gaining exposure to a rise in the stock price than an outright buy of a call option and is safer than a naked written put.
The risk potential for the Bull Put spread is calculated as follows: Maximum Risk = Difference between long and short put strike prices – initial credit. The Loss potential = short put strike price – long put strike price – initial credit
The reward potential for the Bull Put spread is calculated as follows: Maximum Profit = initial credit. Profit = short put premium – long put premium
Net Credit = money received from selling in-the-money puts - money paid for buying out-of-the-money puts
There are different strategies to use when looking for Bull Put spreads. One would be look to initiate the spread on dips or pullbacks in a strong bull market or to look for the lower end of the trading ranges before initiating the spread. A second idea is to initiate this spread by looking for a good strike to sell is the “at-the-money” put or the just “outside-the-money” put to give you the greatest time value. If the stock makes a strong move up, it is reasonable to roll the spread up (to buy back the short put at a lower price and to sell another one at a higher price). If the underlying stock drops, you can also undertake a protective action where you buy back the short put at a loss and sell another one at a lower strike. It is better to sell the at-the-money put which contains more time value. Remember that the price of the protective put you bought goes up. Rolling your spread down you can reduce your losses even more.
Advantages Of Bull Put Spread:
1) The loss is limited if the stock falls instead of rising.
2) If the stock fails to rise beyond the strike price of the out of the money short put option, the profit yield will be greater than just buying call options.
3) You will be able to profit even if the stock remains stagnant.
Disadvantages Of Bull Put Spread:
1) Often there will be more commission involved.
2) Your profits are limited.
3) Credit spreads usually require margin requirements to put on the position.
4) If the short put remains in the money, there is a possibility of it being assigned.
You may then have to purchase the stock to meet the short put obligation.