Bear Put Spread Option Strategy | Buying Puts Vs. Put Spread

welcome to the vertical spread options trading channel my name is Eric and one of the questions I get a lot is when people are bearish on something they they want to know you know should they consider just buying puts or buying a put spread and I want to talk a little bit in this video about the differences and why I think you should really consider put spreads over just regular puts and let's talk about why so first of all I'm going to just kind of do this example on the SP why this is by no means recommendation to short the SP why or anything this is more just talking about if you have the analysis that's telling you I want to get bearish exposure on the SP why and there's a couple ways to do that we're going to compare puts and put spreads and so first of all we're looking at the SP y and we're have this little pattern here and I'm just going to kind of pretend that you know the SP Y sort of gapped up and we're trading a little bit of a bull flag here but my analysis is telling me that I think that we pull back at some point and fill the gap right so here's the gap again that's just hypothetical I'm not taking this trade we're just talking about an example here we think in our hypothetical example that the SP Y is gonna pull back to about this to 46 to 47 area about we're gonna call it to 46 and a half okay technically the gaps at to 46 61 or something so so let's look at a couple ways we can trade this or express our theory in the market that's the great things about options is that you actually get to express what you think is gonna happen and and make me know what or what won't happen in this case we think the markets gonna pull back here a few points so we're gonna go back from you know to 249 and a half to about 246 and a half so we think it's going to be in modest little pullback and we want some bearish exposure so what we're gonna do is we're gonna go over to the analyze tab and the first thing we're gonna do before we jump in the options I just want to kind of compare what it would be if we just straight-up shorted the SP Y so I'm gonna sell and I'm gonna come down here and we're gonna say we're gonna sell 100 shares because all options are based on a hundred shares of the underlying and let's go to the risk profile and this is something that a lot of people just haven't gotten into and you really need to understand the risk profile so here I'm going to they call them slices which are these little lines we're gonna set a slice to basically a break-even level so what this means is very kind of a oversimplification here is that right now we're trading at 240 905 this before the market I'm doing the video and it's very simple we have a delta of 100 because if the SP were to pull back $1 we would make about $100 or we would be up $100 and again we have a if the market were to rally up $1 we would lose about $100 so this is the price this is how much we make and this is sort of our profit and loss right now so this purple line and now I'm gonna zoom over a little bit you'll notice that that there's just it just keeps going because it's unlimited reward as well as technically it's not unlimited losses but if the market were go to zero you would lose a lot of money but just the idea that just straight shorting the stock without any options there's really unlimited gain but also you know in theory unlimited losses again zero is a bottom we don't think the SMP would ever go to zero but it could be substantial losses so you know we don't want to do that and again the buying power you know we won't talk about that but it's extremely high you need a lot of capital to short a hundred shares so so we're gonna we're gonna skip that so let's go ahead and go back and instead of shorting the SP let's look at buying a put option now I'm gonna go with something that's slightly in the money we're training for 249 we'll call it 250 ish and I'm gonna look at buying the 251 put and we're just gonna look at the front month and we can talk in other videos about you know time you know in theory you know we're looking at this if it pulls back for two weeks I think slightly in the money option oops slightly in the money option with 25 days left it should be sufficient so we're going to will get buying one October 251 put and this cost us about two 2.50 cents or about $250 so let's look at this and see what this looks like on the risk diagram so we can see it looks a lot different let me spread this out a bit and the reason why is now you have two lines and the reason why you have two lines is that the Purple Line just like in the short stock example is the right now line the right now line is going to continue to move to the blue line it will eventually get sucked into the blue line the blue line is what this option will be worth at expiration depending on the price level that you're looking at in our first example the the break-even and this is something that's really important the break-even here on I mean I'm gonna make this red just so we understand when we shorted the stock that breakeven was right at the price if the stock were to rally we would lose money and we would make money on the way down so if we look at the risk profile for the put option we're gonna reset the break-even and we're gonna do the break-even to the October expiration and you'll notice that it kind of jumped over a little bit so the break even for this put options just straight up is that to 4849 so let's look at that in a chart I'm gonna edit this and we're gonna change it to two 48 49 or I think was 89 I'm sorry and we'll double-check that and you'll see what happens the line actually moved down it was 248 49 I'm sorry let me fix that edit to 48 49 okay so right away we noticed that when we buy that put option that if the market were to continue to trade sideways we would lose money because our breakeven is back here we need the market to move it to at least this level to order and we're gonna make any money at expiration now if your timing is impeccable in the market were to you know tank right away then yeah you can make a little money but if if you do not get past this level you're most likely you are going to lose money on the option trade now let's let's set we're going to add a slice here just so we can kind of see this and we're gonna move it to the two 4650 level so if at expiration the if you were holding the put option that we paid two dollars and fifty cents for and we were right in our analysis at expiration the put option would be were would have a profit of about two hundred dollars okay that's about an eighty percent gain so if we buy the put option let's let's just say that we're right in our analysis we buy the put option here and and at expiration and move down to this level we're gonna make about two hundred dollars okay so that's pretty good it's about that's the equivalent of about an eighty percent gain okay so that's that's not too bad the problem with this trade is if it doesn't move to this level or or it kind of just sided meanders here around let's say it gets to 248 never makes it there's a decent chance you're not going to make money or you're gonna lose money because again we have a time value here that's going to erode and the and the option will lose money over time so again if we only Trey even if we get to 248 well we won't make as much but you know the worst-case scenario here is that if it trades sideways we actually lose money so you know for this to in order to buy the put we really need to be right in our directional analysis okay so let's let's get rid of that for a second and let's change the trade to a put spread and instead of just buying the 251 I'm gonna buy the 251 put and I'm gonna sell the 249 so I'm gonna sort of straddle the price with a put spread so I'm gonna right click here and I'm gonna do a vertical and we set this we're going to sell the 249 okay so the first thing you'll notice here is that when we buy buying the 251 and selling the 249 we've just reduced our cost now this trade is only 82 cents and the max gain here is the difference in the strike so we can actually make more than the debit here so this is the most we can lose very similar to the put option that was most we can lose when we bought that other put is the debit we paid so in this case we're risking less per contract or per spread I should say to put this trade on so let's go ahead and look at the risk profile this and now you can see that the levels kind of change a little bit so now we no longer have sort of an unlimited war reward and that was something that we didn't discuss when we talked about buying a single put how we bought the single put and the market tanked way down here we could have made a lot more money but that's not what our analysis says our analysis isn't necessarily bearish we just think we're getting a pullback here so again the most we can lose now is is 82 cents or eighty two dollars per spread and you can see now that the profit is capped so if we get down to this to 48 to 49 level the most we can make and you can look at this is 118 dollars which is more than what we paid so it's over a hundred percent gain if we get some kind of pullback so now the break-even for this particular trade is now it is up here at 250 we'll call it 250 18 so let's see what that looked at this looks like this is the break-even so it's going to be two fifty eighteen now just just think about what what this looks like now before when we shorted the stock the breakeven was right at the price now with the put spread our breakeven actually moves up meaning that if as long as the market stays below this 250 and change level we can actually make money so we don't we don't actually have to be right now if we're right will will actually have a decent trade but even if we're a little bit right or a little bit wrong or the market just trades sideways we can still be profitable or at least not lose money in this trade and let's talk about for a second what that profit is so now that our breakeven is here if we get below the 249 level which is the short strike we sold we can achieve max gain and export which in this case would be $118 if I bring up Mont bring up the calculator real quick and move this over here so our max gain is $118 well if we divide that by our price that we paid 82 cents we could actually make about a hundred and forty percent gain whereas previously if our max gain was two hundred which we talked about in the option example and we divide by the price that we pay we pay whoops 251 I think it was our max gains about 80 percent so by reducing our cost and by straddling the strike price we were able to improve raise our breakeven so that our analysis doesn't have to be right and we're able to have a greater percent gain if our analysis is right by reducing our costs and so this is the main thing I wanted you to sort of take away with buying put spreads instead of straight puts you're not you're timing doesn't have to be as perfect you will need to stay in the trade longer though if if it does you see the purple line if the market were to tank all of a sudden then you wouldn't realize this game till closer to expiration but that's okay you know there's a couple nuances there but the main thing I wanted you to take away with from this video is that we reduce our cost and we raise our breakeven and thirdly our profit percentage can be greater by simply doing a put spread that straddles the current price so I hope that helps be sure to subscribe and like this video and definitely check out the resources in the description I got some other things for you guys there to help improve your trading I hope that helps you guys have a great day and we'll see it the next video

Channel: Stock Market Options Trading

Views: 11,170

Rating: 4.8928571 out of 5

Keywords: bear put spread option strategy, buy put options strategy, debit spread options, debit spread strategy, put debit spread, put spread strategy, put vs. put spread, vertical put spread, debit spreads, debit spreads options, reduce risk options, trading debit spreads, using options to reduce risk, vertical debit spreads, why using options is an effective way to reduce the overall risk in a portfolio, buying a put option vs. buying a put spread., SPY Options, $SPY Options, vsa

Id: NijgP4F7rJA

Length: 12min 58sec (778 seconds)

Published: Mon Sep 25 2017