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Bear Put Spread - Introduction
Bear Put Spread - Introduction
A Bear Put Spread is a bearish option strategy that profits when the underlying stock falls. A Bear Put Spread is the reverse of a Bull Call Spread and works the same way in the opposite direction. The Bear Put Spread involves simultaneously buying to open and selling to open options of the same expiration month, making it a Vertical Spread and because you need to pay money to put on this position, resulting in a net debit, this is also a Debit Spread.
A Bear Put Spread is also a technique to buy put options at a discount. Because you sell to open an Out of the Money (OTM) put option in this option strategy, it effectively reduces your investment on your In the Money (ITM) or At The Money (ATM) Put options. This reduces upfront payment and therefore the risk of the position, making it an ideal option trading strategy for beginners who wish to profit from a down market. |
When To Use Bear Put Spread?
One should use a Bear Put Spread when one is confident in a moderate drop in the underlying asset.
How To Use Bear Put Spread?
Establishing a Bear Put Spread involves the purchase of an At The Money or In The Money put option on the underlying asset while simultaneously writing (sell to open) an Out of the Money put option on the same underlying asset with the same expiration month.
Example : Assuming QQQQ at $44. Buy To Open 10 QQQQ Jan44Put, Sell To Open 10 QQQQ Jan43Put
If you expect QQQQ to go down to near $42 by expiration, you will Sell to Open QQQQ Jan42Put instead. |
Profit Potential of Bear Put Spread :
The Bear Put Spread profits when the stock goes down. When that happens, the long put option goes up in price along with the underlying asset while the short put options continue to decay in premium.
The maximum profit potential of a bear put spread is when the price of the underlying instrument drops down to the strike price of the out of the money short options and beyond where any gain in the long put options is matched exactly by a loss in the short put options.
Profit Calculation of Bear Put Spread:
Maximum Return = (Difference in strikes - Net Debit) ÷ Net Debit
Following up from the above example:
Buy to open 10 QQQQ Jan44Put for $1.05 per contract and sell to open 10 QQQQ Jan43Put for $0.60 per contract
Max. Return = (44 - 43 - (1.05 - 0.60)) ÷ (1.05 - 0.60) = 0.55 ÷ 0.45 = 122%
Max. Risk = Net Debit = $1.05 - $0.60 = $0.45, if QQQQ is > $44
Break Even = Higher Strike - Net Debit = $44 - $0.45 = $43.55 |
Risk / Reward of Bear Put Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
Net Debit Paid
Break Even Point of Bear Put Spread:
BEP: Strike Price of Long Put Option - Net Debit Paid
Advantages Of Bear Put Spread :
Notes and references
- http://www.optiontradingpedia.com/free_bear_put_spread.htm
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