Hello everyone. This is Kirk, here again at optionalpha.com. And in this video tutorial,
we're going to talk about the bull put spread. So, starting with the market outlook as always,
this is a little bit of a complex option strategy. It's not the most complex, but it's not just
your simple run-of-the-mill buying and selling of puts and calls.
So, the bull put spread option is entered when the option trader thinks that the price
of the underlying asset will go up moderately in the near term. So, we're not all too crazy
about being bullishness. We just think that there's going to be a general rise in the
price. We don't think it's going to double in price in the next 30, 60 days. Now, traditionally,
this is known as a put credit spread, since the credits is received upon entering the
trade, and then you hope you keep that entire credit at expiration. Sorry for the typo there.
Keep, keep. So again, this could be considered one of your credit spread strategies. In this
case, a put credit spread.
So, how do you set this up, right? Again, it's very easy. It only takes two options
to set up this particular strategy, but this is where the beauty of creating a strategy
around the market comes into with options. So, bull put spreads are implemented by selling
an at the money put, while simultaneously writing a lower strike out of the money put
of the same underlying security and the same expiration level. Very key there that the
same expiration month.
So in this example to the left with our profit loss diagram, you're going to sell one 45
strike put, and then you're going to buy one 40 strike put. So, you're going to sell the
in the money and buy the out of the money. Now, you can do this with two out of the money
options. The key is that you want to sell the higher priced put, and you want to buy
the lower-priced put when you're doing a bull put spread or a bull put credit spread. That's
the real key there. So, these could be all in the money, at the money, all out of the
money. The key is that you want to sell a higher strike and you want to buy the lower
strike.
Well, what's the risk with this strategy? Well, as you can see on the chart, the maximum
loss on this strategy is limited. The difference between the strikes, less the credit received.
So, the difference between your strike prices 45 to 40, less the credit that you receive
on this. That is the maximum loss you can take in. The worst that can happen is for
the stock to be close lower than the lower strike at expiration.
So again, this lower strike here where the loss diagram creates or starts the flat line
here, your losses are capped right here at $300. So, anything below 40, if the stock
closes anywhere below 40, then your losses are completely and 100% capped. You cannot
lose a dime more, because in that case, both put options expire in the money which creates
the loss.
So, if we talk about profit potential now, we also notice that the top half of our profit
loss diagram is also flat, meaning it's capped to the upside. It doesn't continue on in perpetuity.
The maximum gain on these are capped. The ideal scenario would be to see the stock close
above the higher strike price, so anywhere from 45 higher. In which case, both put options
expire worthless and you pocket the credit.
Again, remember that a bull put spread is just a credit spread. It's just a put credit
spread. So, with a credit spread and/or any option strategy where you receive a credit
initially, you do want all of those options to ideally expire worthless. In which case,
you keep 100% of that credit. So, closing between the strikes though, results in variable
gains or losses. So, if we close anywhere along this diagonal line here, you could have
a loss or you could have a small gain either one.
When we talk about volatility, volatility on this particular strategy is going to be
fairly low. Since the strategy involves being long one put and short one put of the same
expiration period, the effects of volatility are going to really offset each other to a
large degree. So, if you have a positive volatility move here and a negative volatility move here,
for more or less, they're going to offset each other. There's going to be a slight difference
because you are selling and buying at different strike prices. But again, it's only going
to be a very small difference. You're going to have a greater impact on actual underlying
price of the stock.
With time decay, it's the same sort of thing as volatility. So, the passage of time decay
was generally going to help the strategy since it is a short option strategy or an option
selling strategy. And we do want all the options to expire worthless at expiration. But just
like volatility with two put options, the effect of time decay on the both contracts
are going to offset each other. So, where you gain money and time decay on one option,
you're going to lose it on the other one more or less.
With breakeven points on this bull put spread, the strategy breaks even if at expiration,
the stock price is below the upper strike (so again, this is the short strike price
or the short put option) by the amount of the initial premium. So, you can see that
our strike price on the upper strike is 45, so the breakeven point would be 45, less the
initial premium that we received. That would create this area here at 43 which would be
virtually where our option breaks even.
Let's look at an example just to really drive it home here. So, we have a stock price that's
trading at about 43. So, let's just say a stock is trading right here. We're going to
buy one 40 strike put for $100. Again, down here. We're going to buy this one for $100
and we're going to sell this one 45 strike put for $300. So, the net difference between
those two (we outlaid $100, we took in $300) is a credit or money that we received directly
into our account of $200. And you can see that that is where our profit is actually
capped on the top side. Now, our max loss is actually $300. Again, it's the strike price
minus the credit. So, 45 minus 200 is going to be that $300 loss. And again, we have - This
maximum profit is not calculated correctly. But our maximum profit is actually $200 or
the net credit that we received.
Some tips and tricks for bull put spreads or bull put credit spreads. The more out of
the money your strike prices, the more conservative your position. So again, in this example,
we sold these strategy here right at the money, but you don't have to do that. If the market
is trading at 43, you can sell these all the way out, possibly down to 20, 25 in that type
of area. So, higher credits don't necessarily mean it's a better position to have. Generally
speaking, you're going to see an at the money position that's basically a 50/50 flip where
you're going to make about the same as you are going to lose. So, it's just the same
as trading the underlying stock.
So, you do want to have some sort of direction on the market and have some sort of opinion.
You don't just want to trade these and think you're going to take in money every time,
but you want to have some sort of direction on the market. So, the more out of the money
you are, the less your credit is going to be or the less premium you're going to receive,
but the more likelihood is that you're going to keep that premium, since it's far out of
the money.
So, if you're having trouble filling these positions, try legging into the spread. A
lot of option brokers will try to have you enter these at the same time. So, it'll have
you simultaneously place an order to sell the 45 and simultaneously place an order to
buy the 40. And when you do that, you have to have exact fills on all of this. But try
legging into it. So, you buy or sell individually these legs and create the position by the
end of the day.
So as always, I hope you guys really enjoyed these videos. As always, if you liked the
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