Bull Put Spread: An Intermediate Strategy

The Bull Put Spread is an intermediate strategy that can be profitable for stocks that are either rangebound or rising. The concept is to protect the downside of a Naked Put by buying a lower strke put to insure the one you sold. Both put strikes should be lower than the current stock price so as to ensure a profit even if the stock doesn’t move at all.

The lower strike put that you buy is further OTM (stock price > put strike price) than the higher strike put that you sell. Therefore, you receive a net credit because you buy a cheaper option than the one you sell. If the stock rises, both puts will expire worthless, and you simply retain the net credit. If the stock falls, then you breakeven is the highere strike less the net credit you receive. Provided the stock remains above the level, then you’ll make a profit. Otherwise, you could make a loss.

Buy lower strike put + sell OTM put = Bull put spread

Maximum Risk: [Difference in strikes - net credit]
Maximum Reward: [Net credit received]
Breakeven: [Higher strike - net credit]

With bull puts, your outlook is bullish or neutral to bullish. It’s safest to trade this strategy on a short-term basis, preferably with one month or less ot expiration.

Advantages

1.Short-term income strategy not necessarily requiring any movement of the stock.

2. Capped downside protection compared to a Naked Put.

Disadvantages

1. Maximum loss is typically greater than the maximum gain, despite the capped downside.

2. High yielding trades tend to mean less protective cushion and are therefore riskier.

3. Capped upside if the stock rises.

Example

ABCD is trading at $27.00 on May 12, 2004. Buy the June 2004 $20 strike put for $0.50. Sell the June 2004 $25 strike put for$1.00.

Net Credit: Premium sold – premium bought
1.00 – 0.50 = 0.50
Maximum Risk: Difference in strikes – net credit
(25-20) – 0.50 = 4.50
Maximum risk is greater than your net credit
Maximum Reward: Net credit
0.50
Breakeven: Higher strike – net credit
25.00 – 0.50 = 24.50
Max ROI: 11.11%
Cushion: $2.50 or 9.26% from breakeven

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