Bull Put Spread Strategy: Everything You Need to Know | Espresso

What is Bull Put Spread Strategy?

A bull put spread strategy is an options tactic that you can use if you expect the underlying stock’s price to witness a moderate increase. This type of strategy is usually profitable when the stock/index is rising, or range bound.

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The tactic uses two put options – a high strike price and a low strike price - to create a range. The objective of the bull put spread strategy is to shield the downside of a put sold by taking a lower strike put that covers the put sold. The difference between the premiums of the two options is your net credit from the trading transaction.

Here is everything you should know about the bull put spread strategy.

What is a Bull Put Spread Strategy?

A bull pull spread strategy consists of one short put that has a higher strike price and one long put consisting of a lower strike price. The underlying stock and the date of expiry for both the puts is the same. The objective of the bull put spread is to make a profit and realise net credit because of a rise in the share price or time erosion, or a combination of both factors.

In this trading strategy, your potential profit is limited – net premium less the commission paid. Your net loss from the strategy is also restricted by the amount when the stock price is below the strike price of the long put.

Bull Put Spread Example

Sell 1 XYZ 100 put at 4.20

Buy 1 XYZ 93 put at 1.30

Net credit = 2.90

The difference between the strike prices is 7 (100-97), and the net credit is 2.90 (4.20 – 1.30). Hence, the maximum amount of risk is 4.10 (7 – 2.90) per share less the commission.

  • Maximum gains = Net premium received
  • Maximum loss = Strike price of short put – strike price of long put – net premiums received
  • Break-even point = Stroke price of short put – net premiums received

What are the Advantages of Using the Bull Put Spread Strategy?

As a trader, you can use the bull put spread strategy because of its advantages, such as:

  • The risk of loss in this strategy is limited to the difference that is there between the strike price of the long and short put. There is a low chance of this position incurring a large loss.
  • The bull put spread strategy uses the concept of time erosion to increase the net credit.
  • The bull put strategy can be modified according to your risk appetite. For example, if you are a low-risk trader, you can opt for a narrow spread where the put strike prices are close, aiming to reduce the risk and maximise the gains. Alternatively, an aggressive, high-risk investor can maximise gains by spreading the put strike prices far apart.
  • This strategy requires a low trading margin compared to put writes.

What are the Disadvantages of Using The Bull Put Spread Strategy?

Here are some drawbacks of the bull put spread strategy that you should be aware of:

  • Potential profits from this investing strategy are limited and are often insufficient to justify the risk of loss if the tactic does not work favourably.
  • This strategy is more suitable in markets that function sideways and eventually go high up. However, the range of ideal market conditions in this strategy is restricted.
  • If the strike prices of the short put and long put has a long difference, the risk of assignment on the short put before the expiration is strikingly high.

Important Things to Consider When Applying the Bull Put Spread Strategy

Here are some aspects you should consider when applying the bull put spread strategy:

  • Impact of stock price change

In a bull spread, a rise in underlying stock price is beneficial, and a fall in the price is disadvantageous. However, since the strategy consists of a long and short put, the net price change is small because the stock price changes but the time to expiration is the same.

  • Impact of market volatility

Volatility measures the change in stock prices and is expressed as a percentage. As the market volatility rises, option prices generally increase if the other factors like stock price and time to expiration do not change. However, in the case of market volatility, the price of the bull put spread changes only minutely, and other factors remain constant.

Conclusion

Overall, a bull put spread is a wise strategy if you want premium income or buy stocks at a price effectively lower than the market price. However, while the bull put spread strategy has limited risk, its ability to generate profits is also restricted. If you are a conservative investor, the bull put spread strategy might be the right fit for you.
Also Read: Bull Call Spread Strategy

 

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Frequently Asked Questions

A bull put spread strategy is good for traders who desire to limit risk. The maximum potential of loss in this strategy is limited to the difference between the strike price of the long and short put.

In a bullish position, the credit put spread allows you to earn profits when the premium you pay for the option you buy is lower than the premium you get from the option sold.

You can use the bull put spread strategy even with a low margin in your account. The margin requirement for a vertical spread is the difference in strikes minus the premium received.