The bull put spread option trading strategy is initiated when the options trader expects the price of the underlying asset will go up reasonably in the short term. The bull put spread options strategy is also called as the bull put credit spread as a credit is received upon executing the trade.
Bull Put Spread Formula
- Buy 1 OTM Put.
- Sell 1 ITM Put.
Bull put spreads can be executed by buying a lower striking out-of-the-money put option and selling a higher striking in-the-money put option on the same underlying stock with the same expiration date.
If the stock price closes above the higher strike price on expiration date, both options expire zero and the bull put spread option strategy yields the maximum profit which is equal to the credit taken in when entering the trade.
- Max Profit = Net Premium Received – Brokerage Paid.
- Max Profit Achieved When Price of Underlying >= Strike Price of Short Put.
If the stock price close below the lower strike price on expiration date, then the bull put spread strategy incurs a maximum loss equal to the difference between the strike prices of the two puts minus the net credit received when putting on the trade.
- Max Loss = Strike Price of Short Put – Strike Price of Long Put Net Premium Received + Brokerage Paid.
- Max Loss Occurs When Price of Underlying <= Strike Price of Long Put.
When the price of underlying asset is equal to the difference of strike price of short put and net premium paid.
- Breakeven Point = Strike Price of Short Put – Net Premium Received
Bull Put Spread Example
An options thinks that ABC stock trading at $66 is going to rally soon and enters a bull put spread by buying a JAN 60 put for $100 and writing a JAN 70 put for $300. Thus, the trader receives a net credit of $200 when entering the spread position.
The stock price of ABC begins to rise and closes at $71 on expiration date. Both options expire zero and the options trader keeps the entire credit of $200 as profit, which is also the maximum profit possible.
If the price of ABC had declined to $58 instead, both options expire in-the-money with the JAN 60 put having an intrinsic value of $100 and the JAN 70 put having an intrinsic value of $600. This means that the spread is now worth $500 at expiration. Since the trader had received a credit of $200 when he entered the spread, his net loss comes to $300. This is also his maximum possible loss.