Bull Put Spread: Trade Example

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This is a past recommendation on PBL which demonstrates how the bull put spread strategy works in real life.

Trade:

Bull Put Spread

Sell 10 PBL39 Oct 1950 Puts @ 22

Buy 10 PBL36 Oct 1900 Puts @ 12

Net Credit = 10 cents

This trade requires minimal margin requirements.

Maximum Profit

The ideal result is for both options to expire worthless, so that maximum premium is retained from the credit spread.

= Net Premium Received

= Sold Put Premium – Bought Put Premium

= (0.22 – 0.12) x 10 contracts

= $1000

Maximum Loss

This will occur if the share price is below the bought at expiry

= Difference between strike prices less net premium received

= 50 – 10

= 40

= 0.40 x 10 Contracts

= $4000

Breakeven

Upper strike less net premium received

= 19.50 – 0.10

= 19.40

Main Benefits of Strategy

1. Provides leveraged exposure to a rise in the share price

2. Takes advantage of time decay

3. The ideal result is for the options to expire worthless, which means the client will save on brokerage not having to close the position to take a profit.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread vs. Sold Put

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A number of advantages are evident when trading bull put spreads compared to selling puts (naked puts). A bull put spread has considerable lower risk than just selling a put which has a much larger risk. The bull put spread has a much better risk vs. reward than selling naked puts. Selling puts can have benefits when combined with portfolios that can help produce income and purchase stock below market value. This strategy is detailed in the Income Strategy E-Book and will be available later in the course.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Strategy Risks

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It is important to always be aware of the strategy risks. The primary risk when placing a bull put spread is when the share price decreases past the sold put and an ever greater concern is if the share price decreases below the bought put (protection). Since you receive a premium to enter this trade there is a required margin. This margin can increase to as much as 1.2 times your maximum loss. For example if you were risk $2,000 the cash margin required in the account can increase to $2,400 (2000 *1.2) which includes the premium received. So it is important to know your maximum risk and make sure there are enough funds to cover the worst case scenario.

Another risk inherent with selling options is volatility. When you open the bull put spread you want the volatility to be high so you can sell the put options for as much value as possible. Once the trade is placed you want the volatility to drop off and time decay to kick in. So even if the share price stays still but volatility increases the position may not profit in the short-term. Increased levels in volatility mean to close out it will cost more to buy back the sold put. If the share price decreases below the sold put prior to expiry there is potentially a risk of exercise.

Exercise

The main risk of credit spreads is the risk of being exercised. If the sold put is exercised it means that you are obligated to buy shares at the exercise price of the sold put. This can have a negative impact in terms of you have bought shares you do not own which means you need to sell them back at the lower level and therefore locking in a loss on the share position. If the share price is below the bought put (protection) when exercised then you can sell the put option which will reduce the loss from being exercised. It is still not possible to lose more than the maximum risk before entering the trade. Another disadvantage of being exercised is the brokerage on the share purchase and sale so it is a good idea to try an avoid exercise. To avoid being exercised you need to monitor your position and more importantly the delta on the sold put. If the share price is below the sold put an indication of the likelihood of being exercised can be identified by the delta. If the delta on the sold call is below -0.95 there is a chance being exercised. If the delta is below -0.98 then it is necessary to implement one of your exit strategies.

To avoid exercise there are two options. If you think the share price will keep decreasing you can close the trade for a loss. If you think you view is correct and the share price will rise from this level and want to keep the position you can roll out to the next month. What this means is you can close the positions you have an open the same position for the next month and do this for no cost or a small credit. Therefore if the share price then increases above the sold put by the next month you can still make maximum profit.

To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Trade Analysis – Risk vs. Reward

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Trade Analysis

Analysing your trade is essential before placing the trade. You need to make sure you have the necessary detail and go through the following checklist:

  1. Stock Selection: Double check your analysis on the stock and make sure your outlook on the share price reflects the bull put spread.
  2. Determine max loss and check that that is suits your risk profile and how much of your trading account you are risking.
  3. Determine premium received when entering trade, most important as it is also your maximum profit.
  4. Make sure you risk vs. reward suits the trading strategy.

Risk vs. Reward

The risk vs. reward will be different for every strategy. Credit spreads have a lower risk reward meaning the maximum profit (reward) is quite low relative to the maximum loss (risk). This trade can be positioned to risk $0.50 to make a $0.50 this is when the bull put spread is traded at-the-money. The trade can be more cautious by selling out-of the money options where you risk $0.80 to make $0.20. Both trades work well at the right time but the first example only requires a 50% success rate to break even while the second example requires an 80% success rate to break even.

Author: Matthew Gartrell

To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Technical and Fundamental Analysis

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Technical Analysis

Identifying bull put spread can be assisted through technical analysis. Technical analysis allows identification of expected price movement through indentifying trends through momentum indicators and trend lines. The types of chart patterns you are looking to identify a bull put trade are:

  • Strong support levels
  • Uptrend
  • Lower end of trading range
  • Oversold indicators – MACD and Stochastic.

Fundamental Analysis

Fundamental analysis can determine if the bull put outlook is aligned with the company news and research. There are a number of fundamental factors that influence the option prices of a stock. When identifying a bull put spread you have a bullish to neutral outlook on the share. Therefore you are looking for positive news in the company or sector. As this trade also makes money if the share price does not move, if there is no news coming out of the company for the next month this can also be a positive for this particular strategy.

To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Advantages and Disadvantages

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Advantages of Bear Put Spread

  • The loss is limited if the underlying share price falls instead of rises.
  • If the share price fails to stay above the strike price of the sold put option, the profit yield will be greater than just buying call options.
  • Able to profit even when the share price remains completely still.
  • Lower risk than simply writing naked put options as maximum downside is limited by bought put option.

Disadvantages of Bull Put Spread

  • There will be no more profits possible if the underlying asset rises beyond the strike price of the sold put option.
  • Because it is a credit spread, there is a margin requirement in order to place the trade.
  • As long as the sold put options remain in-the-money, there is a possibility of it being assigned. You may then have to purchase the underlying stock to meet the sold put obligation.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Identifying Trades – The Greeks

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Delta

When identifying trades it is essential to look at the delta of the option legs. In particular it is important to calculate the net delta of the bull put spread. The net delta is calculated by the delta of the sold put option minus the delta of the bought put option. The net delta will always be negative. The net delta indicates if the share price increases quickly what the value of the bull put spread will be worth. For example, if a bull call spread had a net delta of -0.20, and the share price decreased by $1.00, the bull put spread would have decreased by 20 cents. Therefore to close out the position you buy back the position for less than the premium received to enter the trade.

 

Vega

The volatility affect on a bull put spread is positive. When looking to enter a bull put spread you look to sell an out-of-the-money put option. The idea is to sell a put option which has a relatively high volatility and therefore trading above its theoretical value. The bought put even further out-of-the-money and you want to buy this option with low volatility. When entering the trade you want to volatility to be high and decrease throughout the trade.

 

Theta

Credit spreads are set up to take advantage of time decay. The effect of time decay on this strategy varied with the underlying share price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the higher strike price of the sold put, profits generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the lower strike price of the bought put, losses generally increase at a faster rate as time passes.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Option Pay-Off Diagram

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It is essential to understand the option pay-off diagram for the option strategy you are trading. It allows you to know to determine at what share price you achieve maximum profit, maximum loss and breakeven level at expiry. The bull put spread is made up of a sold put and a bought put at a lower strike. When combined it creates a bear put spread. See below for how the bull put spread option pay-off diagram is constructed. The dotted green line is the sold put and the dashed green line represents the bought put.

Bought Put


Sold Put


Bull Put Spread


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: The Psychology

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The bull put spread strategy is not as aggressive as the bull call spread. The share price for a bull put spread can move down to the sold put level, sideways or upwards to attain maximum profit, whereas the bull call spread requires the share price to increase to a certain level for maximum profit.

The expected share price movement is neutral to slightly bullish. Selling an out-of-the-money put you receive premium if the share price is above the sold put strike price at expiry and the premium received is the profit. The bull put spread just means you buy a put at a lower level then you sold the put to cap your risk and indentify you maximum loss. The reasons for trading bull put spreads are:

  • Alternative to naked puts (selling puts with no protection) as you have a predefined profit and loss and a better risk vs. reward ratio.
  • Share price outlook may be neutral to slight bullish on the share price due to a support level.
  • Consider the bull put spread when you are expecting a limited rise in the price of the stock.
  • An advantage of placing a bull put far out-of-the-money is that the stock price can increase, stay flat or fall slightly to make a profit. So even if you are wrong you can still profit from the trade.
  • This strategy can be used to produce income.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: The Strategy

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A bull put spread is a moderately bullish option strategy that profits when the underlying share price stays still or increases. A bull put spread is similar to a bull call spread. The bull put spread involves simultaneously selling of a put option at a strike price while also buying the same number of put options of the same asset but at a lower strike. A bull put spread is also a technique to selling naked puts but buying lower puts to reduce the maximum loss. Because the bull put spread is a credit spread, you also make money if the underlying asset does not move through time decay. The bull call spread, on the other hand, would not be able to profit if the stock did not move upward beyond its breakeven point.

Maximum Profit

To achieve maximum profit the share price must be above the sold put strike price at expiry. The maximum profit for a bull put spread is the net credit received.

Maximum Loss

If the stock price decreases below the bought put at the expiration date, then the investor has a maximum loss. The maximum loss is the difference between the sold put and bought put strike price less the net credit received.

Break Even

The breakeven is higher than just selling a put; however the maximum loss is reduced significantly. The break even point is the strike price of the sold put minus the net credit received.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au