Bull Put Spread Strategy

 

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

 

The Bull put spread is another of the 4 types of vertical spreads.

 

Overview/General Remarks

The Bull put spread may well be the best of all the vertical spreads.  I generally like credit spreads and I give a slight edge to bullishness in the market.

Why?

This isn’t a technical answer but I believe 2 things support that stance;

1. People, Corporations, governments, etc. all have a need to invest capital for some reason or another. This, in my opinion forces markets higher by default.

2. I believe that declines in any market happen faster. This means that more time is spent grinding higher.

 

These are just my opinions please take them with salt!

 

Expectations

The Bull Put strategy expects the stock price to move higher. The risks and rewards are limited.

While it’s a hedged bet from the outset the real benefit is the reward gained from time decay. This position benefits further from entering when volatility is relatively high.

WARNING – The Bull Put Spread consists of a short option contract. Be aware of the obligations!

 

Setup/Construction

The setup consists of selling short a put option at a higher strike and simultaneously buying a put option at a lower strike.

 

Example Bull Put Spread

Example trade on SPY etf. Click to Enlarge.

 

Max Reward/Loss

Max reward is the credit received = $.35 or $35
Max loss is strike width minus credit = $1 -$.35 = $.65 or $65

The horizontal sections of the P/L diagram indicate max profit and max loss. The point at which the blue line cross zero represents the break even point for this example.

 

Price Assumptions

Price will remain at or above current value.

 

Key Benefits of the Bull Put Spread

– Hedged

– Minimal risk

– Time decay

– Profit from both stagnant and increasing prices.

 

“The Greeks”

Remember this is a multiple contract position or a spread. As such you’ll be looking at the position greeks to determine portfolio effect. For a recap of the greeks visit the terminology page.

 

Volatility

IV = 13.52%
IV Rank = Less than 1%

Selling the bull call spread with these volatility conditions is NOT preferred.

When volatility is low you’ll want to be a net buyer and when volatility is high you’ll want to be a net seller.

 

Liquidity

SPY remains one of the most liquid vehicles around. Just be sure to check open interest, volume, and bid/ask spread of any vehicle before initiating a position.

 

Probability ITM/OTM

An Important distinction when selling option spreads is the desire for them to finish OTM. This way, the entire net credit from establishing the position is retained.

 

Final Thoughts

Again, the bull put spread trade is one of my absolute favorites. It puts time decay in my favor and profits from no price movement and increasing prices.

With regard to this example. I don’t love the risk/reward payoff of $35/$65. I try to aim for more, if possible. I also don’t love the low volatility market. I would probably avoid this trade at this time.

Have a question? Ask me below.

 

Disclaimer

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