Bear Put Spread Options Strategy (Best Guide w/ Examples)

[Music] hey everybody Chris here from project option and in this options trading strategies video we're going to talk about the barefoot spread now the barefoot spread is constructed by purchasing a put option while also selling another put option at a lower strike price so the barefoot spread is similar to buying a put but the strategy has less risk and also limited profit potential so let's go ahead and get right into the strategy characteristics so the purchase of a put spread is also referred to as a long put spread a put debit spread or a barefoot spread now this is a bearish option strategy that consists of purchasing a put while also selling another put option at a lower strike price now compared to buying a put outright the barefoot spread has less profit potential and less risk so it's a more conservative strategy that is not as aggressive as a bearish play as just buying a put option by itself so the maximum profit potential of a barefoot spread is the width of the put strikes minus the debit paid times 100 now the maximum loss potential is the net debit paid now if you'll recall if you buy a put option the most you can lose is the premium that you pay for the put now with a put spread since we're selling another put against the long put we're going to have a debit that's smaller than just buying the put outright and therefore will have a lower loss potential now the expiration break-even price is going to be the long puts strike price less the debit paid now the probability of profit for a barefoot spread depends on if the spread is in the money at the money or out of the money so if you buy a put spread that's entirely in the money you don't need the stock price to move to profit in fact the stock price can actually increase and you'll still make money now keep in mind though that you're going to pay more of a premium for an in the money put spread and therefore you're going to have more lost potential and less profit potential now if you buy a put spread where the long put is in the money and the short put is out of the money that's going to be called a at the money put spread and the approximate probability of profit for that position is going to be around 50% now if you buy a put spread that's out of the money so if you buy an out of the money put and sell and even further out of the money put the probability of profit is going to be less than 50% now that's because you're going to need the stock price to decrease significantly just to break even or make any money on the trade now the resulting position after expiration depends on if the spread is entirely in the money or only partially in the money if both puts are in the money the exercise and assignment will offset and no stock position will be taken so the long put will expire to negative 100 shares of stock and this short put will expire to plus 100 shares of stock and those will offset each other and the spread will just settle to its final value at expiration now if only the long put is in the money the position will expire to negative 100 shares of stock per long put contract so if you have a bear put spread and only the long put is in the money at expiration if you don't want a stock position you're gonna have to close that long put otherwise that long puts going to automatically exercise and turn into negative 100 shares of stock per long put contract now in regards to assignment risk the short put is going to be the one that you can be assigned on so if the put spread is deep in the money you're at risk of being assigned on that short put and this assignment of that shortcut will result in a stock position of plus 100 shares per short put contract so now that you know the general strategy characteristics for the bear put spread let's go ahead and look at a hypothetical example and take a look at the expiration risk profile graph so here we have a bunch of strike prices and the corresponding put prices and let's say that when these options prices were quoted let's say the stock price was trading for a hundred and thirty five dollars now let's say we have a bearish outlook on this stock and we buy the 130 120 put spread so we're gonna buy the 130 put for five dollars and we're going to sell the 120 put for two dollars now since we're paying $5 and receiving $2 our net debit on this spread is going to be $3 now since the difference between the strikes is $10 the most this spread can be worth at expiration is $10 and since we paid $3 for it the most we can profit is $7 and the most we can lose is $3 so let's go ahead and take a look at the expiration risk profile graph for this position all right so as previously discussed the most we can lose on this spread is $3 or in dollar terms $300 and the most we can make on the spread is $700 and that's because we paid $3 in premium for a $10 wide put spread and if the put spread is worth $10 at expiration we're gonna make a profit of $7 or $700 so as we can see here we have more profit potential than lost potential and that's going to lead to a lower than 50% probability of profit now that should make sense because the stock price at entry is a hundred and thirty-five dollars but we need the stock to drop to 127 dollars just to break even and we needed below 127 dollars if we want to make any money so since we need the stock price to fall more than eight dollars to make any money this spread has a lower probability of profit and therefore has more profit potential than lost potential so if the stock price is anywhere above 130 at expiration both the long put and the short put will expire out of the money and expire completely worthless now since we paid a net debit of three dollars for this spread we're gonna lose $300 now if the stock price is right at 127 at expiration that long 130 put is going to be worth $3 well the 120 put will expire worthless now since we paid a $3 premium for this spread and the final value of the spread at expiration is $3 if the stock price is at 120 127 we're gonna break even now if the stock price is at 120 or below this put spread we'll have a value of $10 at expiration and since we paid $3 for it our profit will be $700 so now that you've seen the expiration risk profile graph for a barefoot spread let's go ahead and take a look at a few real examples to show you how the barefoot spread performs as the stock price is changing over time so the first example we're going to look at is where a trader buys and out of the money barefoot spread so here's the set up the initial stock price is two hundred and seven dollars and seventy eight cents and to construct this barefoot spread we're going to buy the 205 foot for two dollars in 10 cents and we're going to sell the 200 foot for a dollar and 13 cents now both options are expiring in 35 days so since we're paying two dollars and ten cents for the 205 foot and we're collecting one dollar and thirteen cents for the 200 foot our net debit paid in this example is 97 cents now that brings our breakeven price to the long put strike price of 205 less than ninety seven cent debit which comes out to 204 oh three so we need to stock price below 200 403 to break-even or make money on this trade now the maximum profit potential is going to be the five dollar wide strikes minus the 97 cent debit times 100 which comes out to four hundred and three dollars so since we paid 97 cents for a five dollar wide spread the most we can make is four hundred and three dollars at expiration now the maximum loss potential is going to be the 97 cent debit paid times 100 which comes out to 97 dollars so right off the bat here we can see that the most we can lose is 97 dollars but the most we can make is four hundred and three dollars now since we have significantly more profit potential than lost potential you should know that this spread has a lower than 50% probability of profit so anytime you have a put debit spreader you know any debit spread for that matter where your profit potential is significantly more than your loss potential you have a low probability position so let's go ahead and see how this position performed through time as the stock price changed all right so as we can see here the stock price started right around 207 50 and the long put strike is 205 while the short put strike is 200 and our breakeven price is 200 403 so over the first 15 or 16 days or so we can see that the stock price falls from 207 50 down to 205 now during that time frame the price of the put spread actually fell from 97 cents to you know around 60 or 70 cents and with around 15 days to expiration the put spread was actually worth a dollar 50 and that's because the stock price was falling and actually touched our long put strike of 205 at one point however at expiration the stock price was above the long put strike price of 205 and in that case the entire spread expired worthless so since we paid 97 cents for this spread and it expired worthless our loss would be $97 per foot spread so this just is an example that shows if you buy an out of the money put spread you really need the stock price to decrease quickly and be below your puts your put spreads break-even price at expiration otherwise you're not going to make any money so one of the dangers of buying it out of the money put spread is that you need a big stock price movement in a short period of time and there's generally a low probability of that happening alright so in this next example we're gonna look at a at the money bear put spread so that is when that's that means we're gonna buy a in the money long put and we're gonna sell a out of the money put so here is the setup so the initial stock price is 100 408 and we're gonna buy the 115 put for 1585 and we're gonna sell them 100 put for $7.35 now again both options are expiring in 35 days so the net debit paid in this example is 15 85 - 7 35 which comes out to $8.50 that brings our breakeven price to the long puts strike price of 115 - the 8.50 cent debit which comes out to 106 50 so our maximum profit potential in this case is the $15 wide strikes - the 8 dollar and fifty cent debit times 100 which comes out to 650 dollars now the maximum loss potential is the debit paid of 8 dollars and 50 cents times 100 which comes out to 850 dollars so in this case we can see that the profit potential is actually less than our loss potential which means that this spread has a higher than 50% probability of profit because we have more loss potential than profit potential and also if you look at the break-even price the stock price is actually at one oh four oh eight while our breakeven price is one of 650 so the stock price can rise about two dollars and fifty cents and we can still not lose money on this trait so all of those factors combined tells you that this spread has a higher than 50% probability of profit so let's go set let's go ahead and see what happens as the stock price is changing through time so in this example we can see that the stock price starts right around 104 dollars now our long put strike price in this case is a hundred and fifteen dollars our short put strike price is 100 and our put spread breakeven price is 106 50 so as we can see here as the stock price is decreasing over time the put spread is increasing in value over time now that's because as the stock price continues to fall and is you know well below the short put strike price this but this barefoot spread has a higher and higher probability of expiring in-the-money and therefore the put spreads price is more valuable so since the strikes are $15.00 wide the most this spread can be worth is $15 at expiration now we can see that around 11 days to expiration the spread is actually worth its maximum value of $15 or at least very close to $15 and at that point it would make sense to sell the spread because with 11 days to expiration we've realized essentially the maximum profit potential but if the stock price reverts and somehow ends up you are above $115 at expiration that $15 spread value that we are holding on to now could be worth nothing so if you have a long put spread and it's trading near its maximum profit before expiration it's always a good idea to go ahead and sell that spread because you basically have nothing left to gain but everything left to lose so this is just a simple example that shows when a when you own a put spread and the stock price moves favorably in a short period of time it's very possible to reach the maximum profit potential of the trade well before expiration in which case it's always wise to close the spread alright so in this last example we're going to look at a situation where your trader buys an in the money bear put spread now that means the long put and short put will both be in the money at the time of trade entry so here's the setup the initial stock price is 127 88 and we're gonna buy the 132 put for four dollars and ninety three cents and we're gonna sell the 128-foot for two dollars and 13 cents both options expire in 31 days now our net debit in this case is two dollars and 80 cents because we paid for 93 for the 132 put and received - 13 for the 128 put now that brings our breakeven price to the long put strike price of 132 less the $2 and 80 sent debit which comes out to 129 20 now in this case the spread is four dollars wide and since we paid two dollars and 80 cents for it maximum profit potential is a hundred and twenty dollars so that's the four dollar strike width minus 280 times 100 which comes out to 120 dollars now our maximum loss potential is the $2 and 80 cent debit paid times 100 which comes out to 280 dollars so let's go ahead and take a look at what happens to this spread is the stock price is changing over time all right so as we can see here the stock price starts right around one hundred and twenty-eight dollars and we purchased the 132 128 put spread for a debit of two dollars and 80 cents now unfortunately in this example of the stock price increased steadily and at expiration was just below the long put strike price of 132 now this means that the put spread did not expire entirely worthless at expiration but it was essentially worthless because the long put was only worth a couple cents so since we paid two dollars and 80 cents for the spread and it was essentially worthless at expiration the loss per spread would be around two hundred and eighty dollars so this just goes to show that even when you buy an in the money bear put spread you know you even though you have a high probability of profit there's always the potential for the stock price to increase in which case you're going to lose money when you own a put spread all right so let's go ahead and recap the summary of main concepts from this video so first of all buying a put spread is a strategy used by traders who have a bearish outlook for a stock now the strategy is less risky than buying a put out right but also has less profit potential so you're giving up some of the profit potential by reducing your cost and selling that put against the long put so buying a put spread can have a low or high probability of profit if the profit potential is significantly more than the loss potential the spread has a low probability of profit now if the profit potential is significantly less than the loss potential the spread has a high probability of profit so the ratio between your potential gains and potential losses will always give you an indication of you know that spreads estimated probability of profit now lastly if the long foot is in the money at expiration H we'll end up with negative 100 shares of stock per long put contract so that's a short stock position of a hundred shares per long put now if the entire spread is in the money at expiration the exercise and assignment of the shares offset each other and no stock position is taken well thank you so much for watching this video everybody I hope you learned a lot about a new pair of strategies that you can use in your trading account today if you enjoyed this video please go ahead and subscribe to our YouTube channel so that you can receive all of our new videos as we come out with them [Music]

Channel: projectfinance

Views: 12,080

Rating: 5 out of 5

Keywords: bear put spread strategy, bear put spread option strategy, bear put, bear put spread example, bear put spread, bear spread, bear spread with puts, bear put debit spread, bear put spread options strategy, bear put spread explained, bear, put spread, spread, buy put spread, vertical spread, put vertical spread, vertical spread options, options trading strategies, options, vertical spread option strategy, long put spread, option strategies, projectoption, trading, strategy, puts

Id: Npx2j_bHwnM

Length: 17min 36sec (1056 seconds)

Published: Mon Mar 13 2017