What is a bull put spread?
In summary, a bull put spread is a trading strategy that options investors can use when they are bullish on a stock or asset but only expect to see moderate gains. It’s a combination of both buying and selling options on the same asset and with the same expiration date. The ideal outcome is for the investor to receive a net credit thanks to the premium they receive from the sale of the put option. Potential losses are also capped by purchasing the put. This strategy can be categorised as a vertical spread strategy and is also known as a ‘call put spread’.
How does a bull put spread strategy work?
The strategy requires two put options. First, you as the investor pay a premium to buy one put option on an asset. In parallel, you’ll sell a second put option on the same asset, but with a higher strike price than the option that you bought. This sale results in a premium for you. It is important that both options have the same expiration date. The maximum profit from this strategy will be realised if the value of the underlying asset stays or rises above the high strike price, meaning that you get to keep the premium you earned from selling the put.
That’s because, as you probably know, put options progressively lose their value as the value of the underlying asset increases. That means that both options will expire without any remaining value if the underlying asset’s price finishes higher than the highest strike. In the ideal situation, this means that you get to keep the premium you earned on the sale of the put because it is worthless to the person who bought it. If you are bullish on an underlying stock, you can therefore use a bull put spread to generate income with limited downside.
When is this strategy relevant?
Investors use this strategy when they’re expecting an increase in the underlying value of an asset. Because an option premium is paid for the vertical spread, the value increase must be large enough to make it worthwhile. If the underlying asset only moves by a small amount, this strategy is generally loss-making for the investor.
How is the bull put spread strategy profitable?
As an investor, you’d ordinarily buy put options when you’re bearish on a stock. This means you expect the stock to fall below the strike price of the put. If the value of the stock stays or rises above the strike price on the put’s expiration, the put option you’ve bought will expire, worthless. This is because you would never sell a stock at a strike price that is lower than the market price. As a result, if you’ve bought a put and this situation occurs, the put loses the value of the premium you paid.
On the flip side, being a put seller (otherwise known as the ‘option writer’) gives you completely different priorities: the best outcome for you would be for the value of the underlying asset to rise above the strike price so the put option has no value for the person who bought it. When you sell a put option, you receive a premium and, naturally, you want to keep as much of that sum as possible. If the value of the underlying asset falls below the strike price, however, the option holder has the right to sell their shares at the higher strike price and make a profit. This means that the premium that you receive from selling a put option is reduced depending on how far the stock price falls below the put option's strike. By combining the buying and selling of a put, the bull put spread is designed to take advantage of a stock's rise, allowing you to keep more of the premium earned from selling the put option even if the underlying asset’s value declines.
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