Bear Put Spread Strategy

“The bear put spread is a limited risk/limited reward play”

The bear put is another of the four vertical spreads.

 

Overview/General Remarks

The bear put spread is often overlooked in favor of selling the bear call spread, to put time decay, declining volatility, and stagnant markets on your side. However, if a decline in price is expected the bear put spread offers a higher reward relative to risk which makes it the perfect trading candidate. That said, if a decline in price is expected immediately the long put would be an even better strategy.

 

Expectations

Employ this strategy with an expectation for the stock price to move lower. The bear put is the preferred trade if a decline is expected but timing is unclear. Theta is mitigated, to a degree, but please note the market decline would need to occur within the life of the trade or prior to expiration.

 

Setup/Construction

Buy one put option at a higher strike and simultaneously sell a put option at a lower strike.

WARNING – The bear put spread consists of a short option. Be aware of the obligations! (Being short a put has the obligation of buying 100 shares, if assigned)

 

Example Bear Put Spread

Example trade of SPY etf. Click to Enlarge.

 

Max Reward/Loss

Max reward is the strike width minus the debit = $1 – $.35 = $.65 or $65
Max loss is the debit paid = $.35 or $35

The horizontal sections of the blue line indicate the maximum profit and the maximum loss. The point at which the blue line intersects the zero line is the break even point for this trade at expiration.

 

Price Assumptions

Price will decline prior to expiration.

 

Key Benefits of the Bear Put Strategy

– Low cost

– Hedged

– High degree of success

– Easy

 

“The Greeks”

Remember this is a multiple contract position, or a spread. As such, look at the net Greek position to determine portfolio effect. For a recap of the greeks visit the terms page here.

 

Volatility

IV = 13.67%
IV Rank = Less than 1%

Buying the bear put in these conditions is a GOOD play. We would enjoy an increase in volatility and a decrease in price.

When volatility is low you’ll want to be a net buyer. When volatility is high you’ll prefer net selling.

 

Liquidity

SPY is very liquid. Just be sure to check the open interest, volume, and bid/ask spread of any asset before initiating a position.

 

Probability ITM/OTM

When buying options we prefer them to move ITM. The percentage this example trade will move ITM is 48%.

 

Final Thoughts on Bear Put Spreads

I like this trade given the current market conditions. The market is at an all time high suggesting a pullback is more than plausible, volatility is non existent, and the risk/reward at $35/$65 is optimal. I would probably place this trade (in fact, I actually did and I’ll alert its results via the portfolio page)

Have some questions? Ask me below…

 

Disclaimer

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