Hello everyone. This is Kirk, here again at
optionalpha.com. And in this video tutorial, we're going to talk about the bull put spread.
So, starting with the market outlook as always, this is a little bit of a complex option strategy.
It's not the most complex, but it's not just your simple run-of-the-mill buying and selling
of puts and calls. So, the bull put spread option is entered
when the option trader thinks that the price of the underlying asset will go up moderately
in the near term. So, we're not all too crazy about being bullishness. We just think that
there's going to be a general rise in the price. We don't think it's going to double
in price in the next 30, 60 days. Now, traditionally, this is known as a put credit spread, since
the credits is received upon entering the trade, and then you hope you keep that entire
credit at expiration. Sorry for the typo there. Keep, keep. So again, this could be considered
one of your credit spread strategies. In this case, a put credit spread. So, how do you set this up, right? Again,
it's very easy. It only takes two options to set up this particular strategy, but this
is where the beauty of creating a strategy around the market comes into with options.
So, bull put spreads are implemented by selling an at the money put, while simultaneously
writing a lower strike out of the money put of the same underlying security and the same
expiration level. Very key there that the same expiration month. So in this example to the left with our profit
loss diagram, you're going to sell one 45 strike put, and then you're going to buy one
40 strike put. So, you're going to sell the in the money and buy the out of the money.
Now, you can do this with two out of the money options. The key is that you want to sell
the higher priced put, and you want to buy the lower-priced put when you're doing a bull
put spread or a bull put credit spread. That's the real key there. So, these could be all
in the money, at the money, all out of the money. The key is that you want to sell a
higher strike and you want to buy the lower strike. Well, what's the risk with this strategy?
Well, as you can see on the chart, the maximum loss on this strategy is limited. The difference
between the strikes, less the credit received. So, the difference between your strike prices
45 to 40, less the credit that you receive on this. That is the maximum loss you can
take in. The worst that can happen is for the stock to be close lower than the lower
strike at expiration. So again, this lower strike here where the
loss diagram creates or starts the flat line here, your losses are capped right here at
$300. So, anything below 40, if the stock closes anywhere below 40, then your losses
are completely and 100% capped. You cannot lose a dime more, because in that case, both
put options expire in the money which creates the loss. So, if we talk about profit potential now,
we also notice that the top half of our profit loss diagram is also flat, meaning it's capped
to the upside. It doesn't continue on in perpetuity. The maximum gain on these are capped. The
ideal scenario would be to see the stock close above the higher strike price, so anywhere
from 45 higher. In which case, both put options expire worthless and you pocket the credit. Again, remember that a bull put spread is
just a credit spread. It's just a put credit spread. So, with a credit spread and/or any
option strategy where you receive a credit initially, you do want all of those options
to ideally expire worthless. In which case, you keep 100% of that credit. So, closing
between the strikes though, results in variable gains or losses. So, if we close anywhere
along this diagonal line here, you could have a loss or you could have a small gain either
one. When we talk about volatility, volatility
on this particular strategy is going to be fairly low. Since the strategy involves being
long one put and short one put of the same expiration period, the effects of volatility
are going to really offset each other to a large degree. So, if you have a positive volatility
move here and a negative volatility move here, for more or less, they're going to offset
each other. There's going to be a slight difference because you are selling and buying at different
strike prices. But again, it's only going to be a very small difference. You're going
to have a greater impact on actual underlying price of the stock. With time decay, it's the same sort of thing
as volatility. So, the passage of time decay was generally going to help the strategy since
it is a short option strategy or an option selling strategy. And we do want all the options
to expire worthless at expiration. But just like volatility with two put options, the
effect of time decay on the both contracts are going to offset each other. So, where
you gain money and time decay on one option, you're going to lose it on the other one
more or less. With breakeven points on this bull put spread,
the strategy breaks even if at expiration, the stock price is below the upper strike
(so again, this is the short strike price or the short put option) by the amount of
the initial premium. So, you can see that our strike price on the upper strike is 45,
so the breakeven point would be 45, less the initial premium that we received. That would
create this area here at 43 which would be virtually where our option breaks even. Let's look at an example just to really drive
it home here. So, we have a stock price that's trading at about 43. So, let's just say a
stock is trading right here. We're going to buy one 40 strike put for $100. Again, down
here. We're going to buy this one for $100 and we're going to sell this one 45 strike
put for $300. So, the net difference between those two (we outlaid $100, we took in $300)
is a credit or money that we received directly into our account of $200. And you can see
that that is where our profit is actually capped on the top side. Now, our max loss
is actually $300. Again, it's the strike price minus the credit. So, 45 minus 200 is going
to be that $300 loss. And again, we have - This maximum profit is not calculated correctly.
But our maximum profit is actually $200 or the net credit that we received. Some tips and tricks for bull put spreads
or bull put credit spreads. The more out of the money your strike prices, the more conservative
your position. So again, in this example, we sold these strategy here right at the money,
but you don't have to do that. If the market is trading at 43, you can sell these all the
way out, possibly down to 20, 25 in that type of area. So, higher credits don't necessarily
mean it's a better position to have. Generally speaking, you're going to see an at the money
position that's basically a 50/50 flip where you're going to make about the same as you
are going to lose. So, it's just the same as trading the underlying stock. So, you do want to have some sort of direction
on the market and have some sort of opinion. You don't just want to trade these and think
you're going to take in money every time, but you want to have some sort of direction
on the market. So, the more out of the money you are, the less your credit is going to
be or the less premium you're going to receive, but the more likelihood is that you're going
to keep that premium, since it's far out of the money. So, if you're having trouble filling these
positions, try legging into the spread. A lot of option brokers will try to have you
enter these at the same time. So, it'll have you simultaneously place an order to sell
the 45 and simultaneously place an order to buy the 40. And when you do that, you have
to have exact fills on all of this. But try legging into it. So, you buy or sell individually
these legs and create the position by the end of the day. So as always, I hope you guys really enjoyed
these videos. As always, if you liked the video, please share the video with your friends,
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