Last Updated on 2025-01-18 by Admin
The Bull Put Spread (also known as a Credit Put Spread) is an options trading strategy that is typically used when an investor has a moderately bullish outlook on an underlying asset. The strategy involves selling a put option at a higher strike price and buying a put option at a lower strike price, both with the same expiration date. This setup results in a net credit to the trader’s account, as the premium received from selling the higher strike put is greater than the premium paid for buying the lower strike put.
The Bull Put Spread is a limited-risk, limited-reward strategy that benefits when the price of the underlying asset stays above the strike price of the put option sold (the higher strike) and the options expire worthless.
Key Elements
- Sell a Put Option (Short Put): The trader sells a put option with a higher strike price. This obligates the trader to buy the underlying asset at the strike price if the option is exercised.
- Buy a Put Option (Long Put): The trader buys a put option with a lower strike price. This limits the risk on the position if the price of the underlying asset falls below the lower strike price.
- Same Expiration Date: Both the put options have the same expiration date.
Objective
The goal of a Bull Put Spread is to profit from a stable or moderately bullish move in the underlying asset’s price. The strategy profits when the price of the asset remains above the higher strike price of the sold put option, allowing both puts to expire worthless and the trader to keep the net premium received as profit.
This strategy is designed to limit risk (because the purchased put provides protection) while providing a defined, capped profit potential.
Mechanics of the Trade
- Sell a Put (Short Put): By selling the higher strike put, the trader collects a premium upfront.
- Buy a Put (Long Put): By buying the lower strike put, the trader pays a premium for the right to sell the underlying asset at a lower price. This option limits the potential loss on the trade.
The combination of these two options results in a net credit, meaning the trader receives more money from selling the higher strike put than they pay for buying the lower strike put.
Maximum Profit
- The maximum profit occurs if the price of the underlying asset stays above the strike price of the sold put at expiration. In this case, both put options expire worthless, and the trader keeps the full premium received for the spread.
Mathematically
- Maximum Profit = Net Premium Received (the difference between the premium received from the short put and the premium paid for the long put).
Maximum Loss
- The maximum loss occurs if the price of the underlying asset falls below the strike price of the bought put. In this case, the trader will have to purchase the underlying asset at the higher strike price (from the short put) but can sell it at the lower strike price (from the long put).
- The maximum loss is the difference between the strike prices of the two puts, minus the net premium received.
Mathematically
- Maximum Loss = (Strike Price of the Sold Put – Strike Price of the Bought Put) – Net Premium Received
Breakeven Point
The breakeven point occurs when the price of the underlying asset is such that the profit from the premium received from the short put is exactly offset by the loss on the long put. It is calculated as the strike price of the sold put minus the net premium received.
Mathematically
- Breakeven = Strike Price of the Sold Put – Net Premium Received
Example
Let’s say a stock is currently trading at $100. The trader is moderately bullish and wants to create a Bull Put Spread:
- Sell a Put Option with a strike price of $95 for a premium of $4.
- Buy a Put Option with a strike price of $90 for a premium of $2.
Net Premium Received
- Premium from selling the $95 put = $4.
- Premium for buying the $90 put = $2.
- Net premium received = $4 – $2 = $2 per share.
Maximum Profit
The maximum profit occurs if the stock price remains above $95 at expiration (both options expire worthless).
- Maximum Profit = Net Premium Received = $2 per share.
Maximum Loss
The maximum loss occurs if the stock price falls below $90 at expiration.
- Maximum Loss = (Strike Price of Sold Put – Strike Price of Bought Put) – Net Premium Received = ($95 – $90) – $2 = $5 – $2 = $3 per share.
Breakeven Point
The breakeven point occurs when the stock price is equal to the strike price of the sold put minus the net premium received.
- Breakeven = $95 – $2 = $93 per share.
Risk/Reward Profile
- Risk: The maximum risk is the difference between the two strike prices, minus the premium received. It is a limited loss, which is one of the key benefits of this strategy.
- Reward: The maximum reward is limited to the net premium received when entering the position, which is the most the trader can earn.
The reward-to-risk ratio can vary depending on the size of the premium received relative to the distance between the two strike prices.
When to Use
- The strategy is best suited when the trader has a moderately bullish outlook on the underlying asset and believes that the price will stay above the strike price of the sold put option.
- The trader expects the asset’s price to either stay stable or rise moderately, but they want to limit the risk and cost of entering a position.
- The strategy works well when implied volatility is high, as the higher premiums can increase the net credit received for the spread.
Pros
- Limited Risk: The maximum loss is capped and known at the time of entering the trade, making it easier to manage.
- Income Generation: The strategy allows you to collect a premium upfront, generating income if the market moves as expected.
- Ideal for a Neutral to Bullish Market: The strategy profits from moderate price increases or stability, making it well-suited for sideways or bullish markets.
- Lower Cost Than Buying a Put Option: Since the sold put offsets the cost of the bought put, the net premium received helps reduce the cost of the trade.
Cons
- Limited Profit Potential: The profit is capped at the premium received, so if the price of the underlying asset rises significantly, the trader will not benefit beyond that point.
- Requires Correct Timing: For the trade to be profitable, the price of the underlying asset must stay above the strike price of the sold put. If the price drops significantly, the strategy will result in losses.
- Obligation to Buy: If the price of the asset falls below the strike price of the sold put, the trader may be obligated to buy the asset at a price higher than its current market value, resulting in a potential loss.
Example Summary
- Stock price = $100
- Sell $95 Put for $4
- Buy $90 Put for $2
- Net Premium Received = $2 per share
- Maximum Profit = $2 (if stock price stays above $95)
- Maximum Loss = $3 (if stock price falls below $90)
- Breakeven = $93 (if stock price is at $93)
Conclusion
The Bull Put Spread (or Credit Put Spread) is a limited-risk, limited-reward strategy used when a trader has a moderately bullish outlook on an underlying asset. It involves selling a higher strike put option and buying a lower strike put option, both with the same expiration date. The strategy benefits from a stable or rising market, with the potential to earn a net premium if the stock price stays above the strike price of the sold put. While the profit is capped, the strategy provides a defined risk and is an efficient way to generate income in moderately bullish market conditions.
