What is Bull Put Spread Option strategy?
A Bull Put Spread involves one short put with higher strike price and one long put with lower strike price of the same expiration date. A Bull Put Spread is initiated with flat to positive view in the underlying assets.
When to initiate Bull Put Spread
Bull Put Spread Option strategy is used when the option trader believes that the underlying assets will rise moderately or hold steady in the near term. It consists of two put options – short and long put. Short put’s main purpose is to generate income, whereas long put is bought to limit the downside risk.
How to Construct the Bull Put Spread?
Bull Put Spread is implemented by selling At-the-Money (ATM) Put option and simultaneously buying Out-the-Money (OTM) Put option of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader.
Probability of making money
A Bull Put Spread has a higher probability of making money as compared to Bull Call Spread. The probability of making money is 67% because Bull Put Spread will be profitable even if the underlying assets holds steady or rise. While, Bull Call Spread has probability of only 33% because it will be profitable only when the underlying assets rise.
Strategy | Sell 1 ATM Put and Buy 1 OTM Put |
Market Outlook | Neutral to Bullish |
Motive | Earn income with limited risk |
Breakeven at expiry | Strike Price of Short Put - Net Premium received |
Risk | Difference between two strikes - premium received |
Reward | Limited to premium received |
Margin required | Yes |
Let’s try to understand with an example:
Nifty Current spot price (Rs) | 9300 |
Sell 1 ATM Put of strike price (Rs) | 9300 |
Premium received (Rs) | 105 |
Buy 1 OTM Put of strike price (Rs) | 9200 |
Premium paid (Rs) | 55 |
Break Even point (BEP) | 9250 |
Lot Size | 75 |
Net Premium Received (Rs) | 50 |
Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will rise above 9300 or hold steady on or before the expiry, so he enters Bull Put Spread by selling 9300 Put strike price at Rs 105 and simultaneously buying 9200 Put strike price at Rs 55. The net premium received to initiate this trade is Rs 50. Maximum profit from the above example would be Rs 3750 (50*75). It would only occur when the underlying assets expires at or above 9300. In this case, both long and short put options expire worthless and you can keep the net upfront credit received that is Rs 3750 in the above example. Maximum loss would also be limited if it breaches breakeven point on downside. However, loss would be limited to Rs 3750(50*75).
For the ease of understanding, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.
The Payoff Schedule:
On Expiry Nifty closes at | Payoff from Put Sold 9300 (Rs) | Payoff from Put Bought 9200 (Rs) | Net Payoff (Rs) |
8800 | -395 | 345 | -50 |
8900 | -295 | 245 | -50 |
9000 | -195 | 145 | -50 |
9100 | -95 | 45 | -50 |
9200 | 5 | -55 | -50 |
9250 | 55 | -55 | |
9300 | 105 | -55 | 50 |
9400 | 105 | -55 | 50 |
9500 | 105 | -55 | 50 |
9600 | 105 | -55 | 50 |
9700 | 105 | -55 | 50 |
Payoff Diagram
Impact of Options Greeks:
Delta: Delta estimates how much the option price will change as the stock price changes. The net Delta of Bull Put Spread would be positive, which indicates any downside movement would result in loss.
Vega: Bull Put Spread has a negative Vega. Therefore, one should initiate this strategy when the volatility is high and is expected to fall.
Theta: Time decay will benefit this strategy as ATM strike has higher Theta as compared to OTM strike.
Gamma: This strategy will have a short Gamma position, so any downside movement in the underline asset will have a negative impact on the strategy.
How to manage Risk?
A Bull Put Spread is exposed to limited risk; hence carrying overnight position is advisable.
Analysis of Bull Put Spread Options strategy:
A Bull Put Spread Options strategy is limited-risk, limited-reward strategy. This strategy is best to use when an investor has neutral to Bullish view on the underlying assets. The key benefit of this strategy is the probability of making money is higher as compared to Bull Call Spread.
How do you rate this article?
