The bull put spread (also known as a “short put spread”) allows investors to bank a limited profit in the wake of a stock’s mild move into the black.

Who should tune in? This strategy is best suited for neutral-to-bullish investors expecting a moderate rise in the underlying stock price. More specifically, this option play is geared toward traders who aren’t yet confident enough in the equity’s upward trajectory to purchase a lone call or sell a lone put on the stock.

How does it work? Once the investor has singled out a stock, she would then sell a slightly out-of-the-money put. However, to help limit her risk in the wake of an unexpected pullback, the investor would simultaneously buy a cheaper, lower-strike put on the same stock with the same expiration date. The premium received from selling the put should be more than the premium paid for the purchased put, resulting in a net credit.

What’s in it for me? Considering it’s a credit spread, the objective of the strategy is for both options to expire worthless, allowing the trader to pocket the initial premium received. In other words, the trader’s goal is attained when the shares finish at or above the higher-strike put at options expiration. However, the net credit represents the most the investor can make on the play, meaning more aggressive traders may want to consider employing a different strategy.

What do I have to lose? Thanks to the “insurance” provided by the long put position, the maximum potential loss on the bull put spread is equal to the difference between the put strikes, minus the net credit received. In order to avoid a capital casualty, the investor needs the underlying security to finish no lower than breakeven, which is calculated by subtracting the initial credit from the bought put strike.

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

In Conclusion…

Short put spreads are great for traders who haven’t totally committed to the bullpen, but who want to capitalize on a potential rally 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 bolder bullish strategies like selling puts, buying calls, or purchasing the stock outright.