Bull Put Spread

Bull Put Spread
June 27th, 2010 | admin | 4 Comments#comments">4 Comments

The bull put spread strategy is used when we thinks that the price of underlying asset will go up moderately in near term. If you think the price will rise a lot, I suggest don’t use this strategy. There are better strategy for that condition. It is implemented by selling an in-the-money (ITM) put option (has higher price) and buying an out-of-the-money (OTM) put option (has lower price) on the same underlying stock with the same expiration date. Bull put spread has limited profit and risk. This type of strategy is known as credit spread where you will get income when entering the position. The amount received by selling higher strike put option is higher than the cost of purchasing put with lower strike.

To understand better, here’s an example. Stock XYZ is trading at $40, and we think it is going to rally soon moderately, so we enter a bull put spread by buying a September 35 put for $100 and writes a September 45 put for $300. Thus, we receives a net credit of $200 when entering this position.

If XYZ begins to rise and closes at $46 on expiration date, both options expire worthless and we keep the entire credit of $200 as profit. This is the maximum profit you can get.

If XYZ decline to $34, both options expire in-the-money. The September 35 call will have an intrinsic value of $200 and the September 45 call will have an intrinsic value of $700. This means that the position is now worth $500 at expiration or $500 loss. Since we had received a credit of $200 when entered the spread, our net loss comes to $300. This is the maximum loss you can have.

The above example did not take commission charges for easy understanding. But you must know the profit and loss also depends on the commision from your brokerage.