Bear Put Spread Guide | Vertical Spread Option Strategies

[Music] welcome back everybody my name is Chris from Project option comm and in this video we're going to talk about the bear put spread strategy so if you've been following along you'll know that this is the fourth installment of the ultimate guide to trading vertical spreads so let's get right to it now as the name suggests the barefoot spread is a bearish options strategy constructed with put options now here's how you set up the trade you're going to start by buying a put option and then you're going to sell another put option at a lower strike price in the same expiration cycle and with the same quantity now with this being a bearish strategy the strategy profits when the stock price decreases and ideally you want the stock price to reach the short puts strike price by expiration now when would you buy a put spread well traders buy put spreads when they believe a stock's price will fall but not necessarily to a price lower than the strike price of the put that is sold so we'll talk more about this in a minute but the basic idea is that when you buy a put spread your maximum profit occurs at the strike price of the put that is sold and it doesn't matter if your stock price Falls another you know 10 20 30 % below that short strike because the put spread will be the worth the same amount at expiration alright so as always let's go right into a real example to demonstrate how the strategy works so first and foremost for this particular position the stock price at the time of entry is 780 dollars and 22 cents now to set up this barefoot spread we're going to buy the 800 foot for $44 in 88 cents and we're going to sell the 750 foot for $22 and 63 cents now both of these options are in the expiration cycle that is 59 days away now when you buy a put spread you obviously are going to pay out premium because the put that you buy is more expensive than the put that you sell so in this case we're buying the 800 foot for $44 and 88 cents but we're collecting 20 2.63 cents from selling that 750 put so in this example our spread entry price is $22.25 all right so the break-even for a bear put spread is the put strike that you buy less the premium that you pay and in this case that's going to be the $800 put strike - twenty two dollars and twenty five cents that we paid to buy the spread which comes out to seven hundred and seventy seven dollars and seventy five cents a lot of sevens there now the maximum profit potential in this case is going to be the spread width which is fifty dollars in this case less the premium paid which is twenty two dollars and twenty five cents times 100 which comes out to two thousand seven hundred and seventy five dollars of profit potential now the maximum loss is the premium that you pay times one hundred so in this case that's going to be twenty two dollars and twenty five cents times 100 which comes out to a maximum loss of two thousand two hundred and twenty-five dollars per spread now this is actually a good time to demonstrate why people buy put spreads as opposed to just buying puts so as we can see the eight hundred foot costs forty four dollars and eighty-eight cents so if you were to just buy that put the maximum loss potential would be four thousand four hundred and eighty eight dollars but by reducing the cost of the trade by selling I put against the long foot we only have a maximum loss potential of two thousand two hundred and twenty-five dollars in this particular case now the downside is that our profit potential will be far less than just buying that put but with all things in options trading there are always trade-offs so in this case the benefit of buying a put spread is that you have a lower cost and therefore less risk but the downside is that you have less profit potential than simply buying a put and not selling it put against it all right well now let's go ahead and take a look at the expiration payoff graph for this particular barefoot spread so let's first start off by discussing the maximum profit zone for this put spread so as mentioned earlier the maximum profit zone is at or below the put strike that is sold so in this case we sold the 750 put against the long 800 foot so that means that if the stock price is at or below 750 dollars at expiration the maximum profit of the trade will be realized now if the stock price is at or below 750 dollars at expiration the 800 750 put spread will be worth $50 since the width of the strikes is $50 now if the spread value goes to $50 that means the profit per spread will be $27.75 because it was initially purchased for $22.25 all right with the maximum profit zone out of the way let's talk about the break-even price so as we discuss the break-even price for this trade is the long put strike of $800 less the premium paid of $22.25 and that comes out to seven hundred and seventy seven dollars and seventy five cents so why is that the break-even price well if the stock price is right at seven hundred and seventy seven dollars and seventy five cents at expiration the 800 foot will be worth twenty two dollars and twenty-five cents because the stock price is $22.25 below that puts strike price now with a stock price above 750 dollars the 750 foot will expire worthless and therefore the net value of the 800 750 put spread will be twenty two dollars and twenty five cents at expiration and since that's the initial purchase price there's no profits and no losses and lastly let's talk about the maximum loss zone for this trade so the maximum loss of a bare foot spread occurs if the stock prices at or above the long put strike price at expiration now in this case the long foot strike price is $800 so if the stock price is at or above eight hundred dollars at expiration the maximum loss will be realized now this is because the 800 foot and the 750 foot will both expire worthless and therefore the value of the 800 750 puts bread be zero dollars now since you paid $22.25 to enter the spread but it expired worth zero dollars the loss per spread is $22.25 now of course we have to multiply that by 100 to get the actual loss of two thousand two hundred and twenty-five dollars per put spread so now that we've talked about the expiration payoff diagram let's go ahead and visualize how this puts bread actually performed as the stock price was changing over time all right so on the right side we can see the chart that shows the changes in the stock price and on the bottom part of this chart we're looking at the changes in the price of this 800 750 foot spread so right off the bat let's focus on the period between fifty nine and twenty five days to expiration so as we can see right when we buy the foot spread the stock price rallies and as we can see on the bottom part of the chart the price of the put spread fall significantly that's because if you buy a put spread and the stock price increases those puts that you purchased are going to decrease in value and that's going to lead to a cheaper put spread since the stock price is now further away from that put spread now if you buy a put spread in its price decreases then you are going to lose money so in this first initial period we can see that we purchased a put spread for $22.25 but the stock price rallies from right around seven hundred and eighty dollars all the way up to around eight hundred and fifty dollars so a very substantial increase in the stock price and with that the price of the put spread decreases significantly so in that first period this puts bread position did not work out well for the person that purchased it now fortunately for this barefoot spread position in the final twenty five days before expiration the stock price goes from eight hundred and fifty dollars all the way down to seven hundred and twenty dollars at the lowest point and as we can see there the price of this puts bread actually got close to fifty dollars which means there was a point in time in which this trade was maximally profitable or at least almost maximally profitable now at expert the stock price was at seven hundred and sixty dollars and sixteen cents so not quite maximally profitable but you know pretty close to it so with the stock price at seven hundred and sixty dollars and sixteen cents at expiration the long eight hundred foot is worth thirty nine dollars in eighty four cents and that's just because the stock price is thirty nine dollars in eighty four cents below the puts strike price now since that seven hundred and fifty foot is out of the money the short 750 put expires worthless and therefore the net value of this 700 or the 800 750 put spread is $39 and 84 cents at expiration now that means the profit per spread is seventeen dollars and 59 cents because the spread is worth thirty nine dollars and 84 cents at expiration but was initially purchased for $22.25 now of course to convert that spread profit to actual profits we simply multiply by 100 and we get to a net profit of one thousand seven hundred and fifty nine dollars in profits per spread so hopefully by looking at this example you can see that when you buy a put spread you want the stock price to decrease and ideally get to a price equal to or lower than the short put strike of your trade now if the stock price increases the price of those puts that you purchase are going to decrease and therefore the price of your spread will decrease and you'll have losses on your position all right well that covers the barefoot spread position and to quickly recap the barefoot spread is a bearish vertical spread constructed with put options now you do so by buying a put and then selling another put at a lower strike price in the same expiration cycle and with the same quantity now ideally the stock price will fall to a price equal to or less than the short put strike price by expiration because that is where the point of maximum profitability occurs now as we mentioned earlier if the stock price plummets through that short put strike price it's not going to be a bad thing for your put spread but if that occurs you would have been better just owning the put well I hope you enjoyed this video and in the next lesson we're going to learn the fourth and final vertical spread which is the bull put spread strategy now after that we're going to start getting to more specific topics such as time decay and implied volatility choosing expirations choosing strike prices and finally when to take profits and losses when trading vertical spreads I'll see you there [Music]

Channel: projectfinance

Views: 28,609

Rating: 4.9014778 out of 5

Keywords: bear put spread guide, put vertical spread, bear put spread option strategy, bear put spread strategy, bear put spread, vertical put spread, bear put spread explained, projectoption, bear spread, put spread, trading, options trading, options strategies, vertical spread, options, vertical spread options strategies, bearish, short, debit spreads, stocks, options trading for beginners, stock market, debit spread, vertical spreads

Id: pTwX7KmCn-w

Length: 11min 37sec (697 seconds)

Published: Thu Jul 20 2017