Bull Put Spread (Short Put Spread)

A Bull Put Spread is an options trading strategy that's employed when an investor anticipates a moderate increase in the price of the underlying asset, or believes the asset will not fall significantly. This strategy involves selling a put option at a higher strike price and buying another put option at a lower strike price within the same expiration period.

The Setup

Suppose you're watching GHI Corp, which is currently trading at $150 per share. Expecting a stable or slightly rising market, you set up a Bull Put Spread by selling a put option with a strike price of $150 for $6 and buying another put option with a strike price of $140 for $3. Both options expire in three months.

Who Should Consider It

This strategy is well-suited for investors who are moderately bullish or expect the stock to remain stable. It's particularly attractive for those looking to generate income through the premiums received from selling the put options, while also seeking to limit potential downside risk.

Strategy Explained

By selling a put at a higher strike and buying a put at a lower strike, you're essentially creating a safety net that limits your maximum loss to the difference between the two strike prices minus the net premium received. This setup helps manage the risk of bearish moves in the stock.

Breakeven Process

The breakeven point for a Bull Put Spread is the higher strike price minus the net premium received. For the GHI example, the net premium received is $3 per share ($6 received - $3 paid), making the breakeven price $147 per share ($150 - $3).

Sweet Spot

The sweet spot for this strategy occurs when the stock price is at or above the higher strike price at expiration ($150 in this example). Under these conditions, both put options expire worthless, and you retain the entire premium received.

Max Profit Potential

The maximum profit for a Bull Put Spread is the net premium received when setting up the spread. In the GHI example, the maximum profit is $3 per share.

Max Loss

The maximum loss is limited to the difference between the strike prices minus the net premium received. This would be $7 per share ($150 - $140 - $3) if the stock falls below the lower strike price.

Risk

The primary risk is that the stock price ends below the lower strike price at expiration, which would result in a loss up to the maximum calculated loss. However, the purchased lower strike put limits the downside, making this less risky than a naked put sale.

Time Decay

Time decay, or theta, positively influences this strategy because the value of both put options will generally decrease as expiration approaches, provided the stock price remains above the higher strike price.

Implied Volatility

An increase in implied volatility typically works against this strategy after the position is established, as it can increase the value of both put options. Conversely, a decrease in implied volatility benefits the position, especially as the expiration approaches if the stock price is above the strike price of the sold put.

Conclusion

The Bull Put Spread is an effective strategy for those looking to benefit from premium income in a rising or stable market while keeping risk under control. It offers a straightforward way to cap potential losses and maximize income from premiums, making it suitable for moderately bullish investors during periods of low to moderate volatility.