Bull Put Spread
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Bull Put Spread
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To profit from neutral to bullish price action in the underlying stock.
A bull put spread consists of one short put with a higher strike price and one long put with a lower strike price. Both puts have the same underlying stock and the same expiration date. A bull put spread is established for a net credit (or net amount received) and profits from either a rising stock price or from time erosion or from both. Potential profit is limited to the net premium received less commissions and potential loss is limited if the stock price falls below the strike price of the long put.
Potential profit is limited to the net premium received less commissions, and this profit is realized if the stock price is at or above the strike price of the short put (higher strike) at expiration and both puts expire worthless.
The maximum risk is equal to the difference between the strike prices minus the net credit received including commissions. In the example above, the difference between the strike prices is 5.00 (100.00 – 95.00 = 5.00), and the net credit is 1.90 (3.20 – 1.30 = 1.90). The maximum risk, therefore, is 3.10 (5.00 – 1.90 = 3.10) per share less commissions. This maximum risk is realized if the stock price is at or below the strike price of the long put at expiration.
Short puts are generally assigned at expiration when the stock price is below the strike price. However, there is a possibility of early assignment. See below.
Strike price of short put (higher strike) minus net premium received.
In this example: 100.00 – 1.90 = 98.10
A bull put spread earns the maximum profit when the price of the underlying stock is above the strike price of the short put (higher strike price) at expiration. Therefore, the ideal forecast is “neutral to bullish price action.”
The bull put spreads is a strategy that “collects option premium and limits risk at the same time.” They profit from both time decay and rising stock prices. A bull put spread is the strategy of choice when the forecast is for neutral to rising prices and there is a desire to limit risk.
A bull put spread benefits when the underlying price rises and is hurt when it falls. This means that the position has a “net positive delta.” Delta estimates how much an option price will change as the stock price changes, and the change in option price is generally less than dollar-for-dollar with the change in stock price. Also, because a bull put spread consists of one short put and one long put, the net delta changes very little as the stock price changes and time to expiration is unchanged. In the language of options, this is a “near-zero gamma.” Gamma estimates how much the delta of a position changes as the stock price changes.
Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to expiration remain constant. Since a bull put spread consists of one short put and one long put, the price of a bull put spread changes very little when volatility changes and other factors remain constant. In the language of options, this is a “near-zero vega.” Vega estimates how much an option price changes as the level of volatility changes and other factors are unchanged.
The time value portion of an option’s total price decreases as expiration approaches. This is known as time erosion. Since a bull put spread consists of one short put and one long put, the sensitivity to time erosion depends on the relationship of the stock price to the strike prices of the spread. If the stock price is “close to” or above the strike price of the short put (higher strike price), then the price of the bull put spread decreases (and makes money) with passing of time. This happens because the short put is closest to the money and erodes faster than the long put. However, if the stock price is “close to” or below the strike price of the long put (lower strike price), then the price of the bull put spread increases (and loses money) with passing time. This happens because the long put is now closer to the money and erodes faster than the short put. If the stock price is half-way between the strike prices, then time erosion has little effect on the price of a bull put spread, because both the short put and the long put erode at approximately the same rate.
Stock options in the United States can be exercised on any business day, and holders of a short stock option position have no control over when they will be required to fulfill the obligation. Therefore, the risk of early assignment is a real risk that must be considered when entering into positions involving short options.
While the long put (lower strike) in a bull put spread has no risk of early assignment, the short put (higher strike) does have such risk. Early assignment of stock options is generally related to dividends, and short puts that are assigned early are generally assigned on the ex-dividend date. In-the-money puts whose time value is less than the dividend have a high likelihood of being assigned. Therefore, if the stock price is below the strike price of the short put in a bull put spread (the higher strike), an assessment must be made if early assignment is likely. If assignment is deemed likely and if a long stock position is not wanted, then appropriate action must be taken. Before assignment occurs, the risk of assignment can be eliminated in two ways. First, the entire spread can be closed by buying the short put to close and selling the long put to close. Alternatively, the short put can be purchased to close and the long put open can be kept open.
If early assignment of a short put does occur, stock is purchased. If a long stock position is not wanted, the stock can be sold either by selling it in the marketplace or by exercising the long put. Note, however, that whichever method is chosen, the date of the stock sale will be one day later than the date of the stock purchase. This difference will result in additional fees, including interest charges and commissions. Assignment of a short put might also trigger a margin call if there is not sufficient account equity to support the stock position.
There are three possible outcomes at expiration. The stock price can be at or above the higher strike price, below the higher strike price but not below the lower strike price or below the lower strike price. If the stock price is at or above the higher strike price, then both puts in a bull put spread expire worthless and no stock position is created. If the stock price is below the higher strike price but not below the lower strike price, then the short put is assigned and a long stock position is created. If the stock price is below the lower strike price, then the short put is assigned and the long put is exercised. The result is that stock is purchased at the higher strike price and sold at the lower strike price and the result is no stock position.
The “bull put spread” strategy has other names. It is also known as a “credit put spread” and as a “short put spread.” The term “bull” refers to the fact that the strategy profits with bullish, or rising, stock prices. The term “credit” refers to the fact that the strategy is created for a net credit, or net amount received. Finally, the term “short” refers to the fact that this strategy involves the net selling of options, which is another way of saying that it is established for a net credit.
Article copyright 2013 by Chicago Board Options Exchange, Inc (CBOE). Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options Opens in a new window . Supporting documentation for any claims, if applicable, will be furnished upon request.
Charts, screenshots, company stock symbols and examples contained in this module are for illustrative purposes only.
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Understanding Bull Spread Option Strategies
Butterfly spread is an options strategy combining bull and bear spreads, involving either four calls and/or puts, with fixed risk and capped profit.
An iron condor involves buying and selling calls and puts with different strike prices when a trader expects low volatility.
A bull spread is a bullish options strategy using either two puts, or two calls with the same underlying asset and expiration.
A collar, commonly known as a hedge wrapper, is an options strategy implemented to protect against large losses, but it also limits large gains.
Options are financial derivatives that give the buyer the right to buy or sell the underlying asset at a stated price within a specified period.
The call ratio backspread uses long and short call options in various ratios in order to take on a bullish position.
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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. A bull put spread is one of the four basic types of vertical spreads - the other three being the bull call spread , the bear call spread and the bear put spread . 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 bull put spread should be considered in the following situations:
A hypothetical stock, Bulldozers Inc., is trading at $100. An option trader expects it to trade up to $103 in one month, and while she would like to write puts on the stock, she is concerned about its potential downside risk. The trader therefore writes three contracts of the $100 puts – trading at $3 – expiring in one month, and simultaneously buys three contracts of the $97 puts – trading at $1 – also expiring in one month.
Since each option contract represents 100 shares, the option trader’s net premium income is:
($3 x 100 x 3) – ($1 x 100 x 3) = $600
(Commissions are not included in the calculations below for the sake of simplicity.)
Consider the possible scenarios a month from now in the final minutes of trading on the option expiration date:
Scenario 1 : Bulldozers Inc. is trading at $102.
In this case, the $100 and $97 puts are both out of the money and will expire worthless.
The trader therefore gets to keep the full amount of the $600 net premium (less commissions).
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.
Scenario 2 : Bulldozers Inc. is trading at $98.
In this case, the $100 put is in the money by $2, while the $97 put is out of the money and therefore worthless.
The trader therefore has two choices: (a) close the short put leg at $2, or (b) buy the stock at $98 to fulfill the obligation arising from exercising the short put.
The former course of action is preferable, since the latter would incur additional commissions.
Closing the short put leg at $2 would entail an outlay of $600 (i.e. $2 x 3 contracts x 100 shares per contract). Since the trader received a net credit of $600 when initiating the bull put spread, the overall return is $0.
The trader therefore breaks even on the trade but is out of pocket to the extent of the commissions paid.
Scenario 3 : Bulldozers Inc. is trading at $93.
In this case, the $100 put is in the money by $7, while the $97 put is in the money by $4.
The loss on this position is therefore: [($7 - $4) x 3 x 100] = $900.
But since the trader received $600 when initiating the bull put spread, the net loss = $600 - $900
To recap, these are the key calculations associated with a bull put spread:
Maximum loss = difference between strike prices of puts (i.e. strike price of short put less strike price of long put) - net premium or credit received + commissions paid
Maximum gain = net premium or credit received - 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.
Breakeven = strike price of the short put - net premium or
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