Put Spread
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Put Spread
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An options strategy that involves purchasing out-of-the-money (OTM) put option and selling an in-the-money (ITM) put option with a higher strike price
A bull put spread, which is an options strategy, is utilized by an investor when he believes the underlying stock will exhibit a moderate increase in price. A bull put spread involves purchasing an out-of-the-money (OTM) put option and selling an in-the-money (ITM) put option with a higher strike price but with the same underlying asset and expiration date. A bull put spread should only be used when the market is exhibiting an upward trend.
To determine the maximum loss and break-even point for a bull put spread, refer to the following formulas:
Note that when the bull put spread position is entered, the investor starts with the maximum gain and faces potential losses as the strategy approaches maturity. Following, we will go through a comprehensive example outlining this.
An investor utilizes a bull put spread by purchasing a put option for a premium of $15. The put option comes with a strike price of $80 and expires in July 2020. At the same time, the investor sells a put option for a premium of $35. The put option comes with a strike price of $120 and expires in July 2020. The underlying asset is the same and is currently trading at $95.
In writing the two options, the investor witnessed a cash outflow of $15 from purchasing a call option and a cash inflow of $35 from selling a call option. Netting the amounts together, the investor generated an initial cash inflow of $20 from the two put options.
Now, assume that it is July 2020. The table below illustrates theoretical stock prices at the expiration date.
At a price of $120 or above, the investor’s gain is capped at $20 because both the long put option and the short put option are out-of-the-money. For example, at the stock price of $125:
Factoring in net commissions , the investor would be left with a net gain of $20.
At a price of $80 or below, the investor’s loss is capped at -$20 because both the long put option and the short put option are in-the-money. For example, at the stock price of $75:
Factoring in net commissions, the investor would be left with a net loss of $20 .
Therefore, in a bull put spread, the investor is:
Applying the formulas for a bull put spread:
The values calculated correspond to the table above.
The comprehensive example above can be visually represented as follows:
Note that the blue line is simply a combination of the two dotted yellow lines.
The payout table below corresponds to the visual graph above.
Jorge is looking to utilize a bull put spread on ABC Company. ABC Company is currently trading at a price of $150. He purchases an in-the-money put option for a premium of $10. The strike price for this option is $140 and expires in January 2020. Additionally, Jorge sells an out-of-the-money put option for a premium of $30. The strike price for the option is $180 and expires in January 2020.
What are the maximum payout, maximum loss, and break-even point of the bull call spread above?
The net commissions is $20 ($30 OTM Put – $10 ITM Put).
Applying the formulas for a bull call spread, Jorge determines:
To confirm, Jorge creates a payout table:
The main reason behind using a bull put spread is to immediately realize the maximum profit upon executing the spread. In the example above, Jorge is able to realize a maximum profit of $20 immediately into executing a bull put spread. In addition, although the maximum gains are capped, the investor is protected from downside risk as well.
However, one significant drawback from a bull put spread is that potential gains are limited. For example, in the example above, the maximum gain Jorge can realize is only $20 due to the short put option position. Even if the stock price were to decline to $0, Jorge would only be able to realize a gain of $20.
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A bull put spread is an options strategy that is used when the investor expects a moderate rise in the price of the underlying asset. An investor executes a bull put spread by buying a put option on a security and selling another put option for the same date but a higher strike price. The maximum loss is equal to the difference between the strike prices and the net credit received. The maximum profit is the difference in the premium costs of the two put options. This only occurs if the stock's price closes above the higher strike price at expiry.
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A bull spread is a bullish options strategy using either two puts, or two calls with the same underlying asset and expiration.
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 Christmas tree is a complex options trading strategy achieved by buying and selling six call options with different strikes for a neutral to bullish forecast.
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.
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Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
A bull put spread is an options strategy that an investor uses when they expect a moderate rise in the price of the underlying asset . The strategy employs two put options to form a range, consisting of a high strike price and a low strike price. The investor receives a net credit from the difference between the premiums of the two options.
Investors typically use put options to profit from declines in a stock's price, since a put option gives them the ability—though not the obligation—to sell a stock at or before the expiration date of the contract. Each put option has a strike price, which is the price at which the option converts to the underlying stock. Investors pay a premium to purchase a put option.
Investors typically buy put options when they are bearish on a stock, meaning they hope the stock will fall below the option's strike price. However, the bull put spread is designed to benefit from a stock's rise. If the stock trades above the strike at expiry, the put option expires worthless, because no one would sell the stock at a strike lower than the market price. As a result, the investor who bought the put loses the value of the premium they paid.
On the other hand, an investor who sells a put option is hoping the stock doesn't decrease but instead rises above the strike so the put option expires worthless. A put option seller—the option writer —receives the premium for selling the option initially and wants to keep that sum. However, if the stock declines below the strike, the put seller is on the hook. The option holder has a profit and will exercise their rights, selling their shares at the higher strike price. In other words, the put option is exercised against the seller.
The premium received by the seller would be reduced depending on how far the stock price falls below the put option's strike. The bull put spread is designed to allow the seller to keep the premium earned from selling the put option even if the stock's price declines.
A bull put spread consists of two put options. First, an investor buys one put option and pays a premium. At the same time, the investor sells a second put option with a strike price that is higher than the one they purchased, receiving a premium for that sale. Note that both options will have the same expiration date. Since puts lose value as the underlying increases, both options would expire worthless if the underlying price finishes higher than the highest strike. Therefore, the maximum profit would be the premium received from writing the spread.
Those who are bullish on an underlying stock could thus use a bull put spread to generate income with limited downside. However, there is a risk of loss with this strategy.
The maximum profit for a bull put spread is equal to the difference between the amount received from the sold put and the amount paid for the purchased put. In other words, the net credit received initially is the maximum profit, which only happens if the stock's price closes above the higher strike price at expiry.
The goal of the bull put spread strategy is realized when the price of the underlying moves or stays above the higher strike price. The result is the sold option expires worthless. The reason it expires worthless is that no one would want to exercise it and sell their shares at the strike price if it's lower than the market price.
A drawback to the strategy is that it limits the profit earned if the stock rises well above the upper strike price of the sold put option. The investor would pocket the initial credit but miss out on any future gains.
If the stock is below the upper strike in the strategy, the investor will begin to lose money since the put option will likely be exercised. Someone in the market would want to sell their shares at this, more attractive, strike price.
However, the investor received a net credit for the strategy at the outset. This credit provides some cushion for the losses. Once the stock declines far enough to wipe out the credit received, the investor begins losing money on the trade.
If the stock price falls below the lower strike put option—the purchased put—both put options would have lost money, and maximum loss for the strategy is realized. The maximum loss is equal to the difference between the strike prices and the net credit received.
Investors can earn income from the net credit paid at the onset of the strategy.
The maximum loss on the strategy is capped and known upfront.
The risk of loss, at its maximum, is the difference between the strike prices and the net credit paid.
The strategy has limited profit potential and misses out on future gains if the stock price rises above the upper strike price.
Let's say an investor is bullish on Apple ( AAPL ) over the next month. Imagine the stock currently trades at $275 per share. To implement a bull put spread, the investor:
The investor earns a net credit of $6.50 for the two options, or $8.50 credit - $2 premium paid. Because one options contract equals 100 shares of the underlying asset, the total credit received is $650.
Let's say Apple rises and trades at $300 at expiry. The maximum profit is achieved and equals $650, or $8.50 - $2 = $6.50 x 100 shares = $650. Once the stock rises above the upper strike price, the strategy ceases to earn any additional profit.
If Apple trades at $200 per share or below the low strike, the maximum loss is realized. However, the loss is capped at $350, or $280 put - $270 put - ($8.50 - $2) x 100 shares.
Ideally, the investor is looking for the stock to close above $280 per share on expiration, which would be the point at which maximum profit is achieved.
Correction–Dec. 24, 2021. A video in this article incorrectly labeled the graphs for Bull Put Spreads and Bear Put Spreads.
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Contents
Call spreads and Put spreads
Payoff Diagrams
Greeks of position
Conditions for position
$52
$55
$50
$51
$53
$54
True
False
It depends
Theta neutral, net option position is 0.
Paying Theta, OTM options have less theta to collect.
It depends on the time to expiry
Collecting Theta, OTM options have more theta to collect
Less capital outlay
Less risk
More profit
More trading
Cite as:
Call and Put Spreads.
Brilliant.org .
Retrieved from
https://brilliant.org/wiki/call-and-put-spreads/
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This is an advanced topic in Option Theory. Please refer to this Options Glossary if you do not understand any of the terms.
A call spread is an option strategy in which a call option is bought, and
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