Beginning Option Strategies/Bearish Strategies

Options 101: The Bear Put Spread

Dissecting a long put spread The bear put spread (also known as a “long put spread”), is an essential tool in the options trader's playbook, allowing traders to make money on a stock’s moderate move into the red, while also capping risk.

Who should tune in? This strategy is best suited for moderately bearish investors anticipating a move lower by the underlying stock, but who have a downside target in mind. In other words, this option play is typically utilized by investors who think the stock is going to decline, but who aren’t confident enough to purchase a lone put.

How does it work? Once the investor has singled out a stock, she would then buy an at- or slightly in-the-money put. To limit her overall risk and help offset the cost of the purchased put, the trader would then sell a lower-strike, out-of-the-money put with the same expiration date. However, since the premium paid for the long put will exceed the premium received from writing the short put, the play will still be established for a net debit.

What’s in it for me? The objective of the bear put spread is for the underlying stock to finish at or slightly below the sold put strike at expiration. However, the investor doesn’t want the stock to fall so far in the red that she regrets not purchasing a single put in the first place. Plus, while the sold put helps to limit the risk of the option play, it also reduces the trader’s potential reward.

As such, the maximum potential profit for this position is limited to the difference between the put strikes, minus the net debit paid. The breakeven level for the debit spread is calculated by subtracting the net debit from the bought put strike.

What do I have to lose? The beauty of this strategy is that the maximum potential loss is limited to the net debit paid at initiation. Simply put, even if the stock price doubles before expiration, the most the investor can lose is the net debit paid. What’s more, since the trader received premium from selling the lower-strike put, the initial debit – and maximum risk – is less than if she would’ve bought a lone put.

In addition, don’t forget to include any brokerage fees when calculating the total cost of this play.

In Conclusion…

Long put spreads are great for traders who haven’t totally committed to the bears’ camp, but who want to capitalize on a potential pullback in the underlying shares. However, while these spreads are less risky than some other option plays, they also come with limited reward. As such, aggressive option players or those who are more confident in their predictions may want to consider more profitable strategies like buying puts or selling the stock short.



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Options Trading Glossary

Schaeffer's Education Image Can't decide whether you should be bullish or bearish? Have yet to understand the concept behind the straddle? This glossary will give you the terms you need to get by in the world of options trading. The glossary has been divided into sections to make it easier for you to navigate. Click below to get started.

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