While trading, you do not always need a significant bullish trend to earn profits. Even a moderate bullish outlook can offer opportunities for gains. The bull put spread strategy (also known as bull put credit spread) is a popular options trading strategy that allows you to profit from slight price rises. Unlike strategies that require a major market surge, this approach can be executed based on modest bullish movements or even sideways trends. Let us understand the bull put spread strategy in detail and learn its execution through easy examples.
What is a bull put spread?
A bull put spread strategy applies to options trading. Using it, traders can profit from a moderately bullish outlook towards an underlying asset. This strategy is best suited when the trader expects the underlying asset to:
- Either rise slightly in value
or - At least remain stable
It is pertinent to note that a significant surge in the market value is optional. A gradual upward movement or a sideways trend can also be beneficial while implementing a bull put spread. Furthermore, this strategy is most profitable when the market exhibits relatively low to moderate levels of volatility. That is because high volatility increases the cost of options premiums and makes the strategy less attractive.
How to execute a bull put spread strategy?
In this strategy, traders simultaneously purchase and sell the put options with:
- Different strike prices
but - The same expiration date
Let us learn how to construct this strategy in simple steps:
Step I: Buying a put option
- Initially, the trader purchases a put option featuring a higher strike price.
- Mostly, this put option is out-of-the-money (OTM).
- This purchase gives them the right to sell the underlying asset at that strike price.
Step II: Selling a put option
- Simultaneously, the trader sells a put option with a lower strike price.
- Mostly, this put option is:
- In-the-money (ITM)
or - At-the-money (ATM)
- In-the-money (ITM)
- By selling this put option, the traders receive a premium.
- However, they also take on the obligation to buy the underlying asset at that strike price.
How this simultaneous sale and purchase creates a ‘net credit?’
As per the general rule of thumb,
- The premium received from selling the put option with the lower strike price is higher than the premium paid for the put option with the higher strike price
By executing both transactions simultaneously, the trader establishes a net credit to their demat account. This net credit represents the maximum potential profit for the trade. Read the table below to understand this better:
Limited loss |
Limited profit |
The loss is capped at the difference in strike prices minus the net credit received. |
The maximum profit is the net credit received when initiating the trade. |
When is the bull put credit spread strategy profitable?
The strategy is profitable if the underlying asset's price remains above the higher strike price (the short put) at expiration.
It can lead to losses if the price falls below the lower strike price (the long put). However, as discussed above, the losses are limited to the difference between the two strike prices minus the net credit received.
Example of the bull put spread strategy
Let us understand all the concepts discussed above through a hypothetical example involving a stock named "ABC Ltd." Consider the following financial data:
- Current Market Price (CMP) of ABC Ltd.: Rs. 150 per share
- Options expiry date: June 30, 2024
- Strike prices
- Short Put (Sell): Rs. 140 per share
- Long Put (Buy): Rs. 130 per share
- Premiums
- Premium paid for buying put (Long Put): Rs. 5 (Step I)
- Premium received for selling put (Short Put): Rs. 10 (Step II)
- Contract size: 100 shares per contract
Now, let us construct the bull put credit spread:
Step I: Buy put option (Long put)
- Bought 1 ABC Ltd. put option with a strike price of Rs. 130 for a premium of Rs. 5 per share
- Paid a total premium of Rs. 500 (Rs. 5 x 100 shares)
Step II: Sell put option (Short put)
- Sold 1 ABC Ltd. put option with a strike price of Rs. 140 for a premium of Rs. 10 per share
- Received a total premium of Rs. 1,000 (Rs. 10 x 100 shares)
The net credit received
- The total premium received from selling the short put: Rs. 1,000
- The total premium paid for buying the long put: Rs. 500
- Net credit received: Rs. 500
Now, we can anticipate two possible scenarios based on the current market price of ABC Ltd. Let us understand them:
Scenario I: When the CMP of ABC Ltd. closes above Rs. 140 at expiry (profitability)
- In this scenario, both the short put (with a strike price of Rs. 140) and the long put (with a strike price of Rs. 130) expire out-of-the-money.
- Both options become worthless as the CMP of ABC Ltd. remains above the higher strike price (short put) at expiration.
- The trader keeps the entire net credit of Rs. 500 received when initiating the trade as profit.
Scenario II: When the CMP of ABC Ltd. closes below Rs. 140 but above Rs. 130 at expiry (limited loss)
- In this scenario, the CMP of ABC Ltd. falls below the higher strike price (short put).
- However, it remains above the lower strike price (Rs. 130) at expiration.
- Thus, the short put is assigned, and the trader must buy 100 shares of ABC Ltd. at Rs. 140 per share.
- Simultaneously, the long put is also exercised.
- This allows the trader to sell 100 shares of ABC Ltd. at Rs. 130 per share.
- The net loss is limited to the difference between the strike prices of the two puts (Rs. 140 - Rs. 130) minus the net credit received (Rs. 500)
Conclusion
The bull put credit spread strategy is commonly practiced by options traders. It allows them to profit from a moderately bullish outlook on an underlying asset. By simultaneously buying and selling put options with different strike prices but the same expiration date, traders aim to generate a net credit to their accounts. This net credit represents the maximum potential profit for the trade. Moreover, traders prefer to execute this strategy when the market exhibits relatively low to moderate levels of volatility.
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