Bull Put Spread Strategy – For Bullish Market
If you want to make money in a bullish market, then you can apply the Bull Put Spread Options Strategy.
When an investor expects a moderate increase in the price of a security; one of the strategies that he/she applies is a Bull Put Spread. This strategy uses a high exercise price Put option and a low exercise price Put option to form a range; and the investor is in a net credit position from the premium difference in buying/selling the options.
Let’s understand how to apply the strategy through an example.
Let’s say there’s a Stock X with below specifications:
Current Market Price (CMP) = $100
1-month $103 Put option premium = $1
1-month $107 Put option premium = $3
To create a Bull Put Spread, the investor would sell 10 units of 1-month $107 Put option; and purchase 10 units of 1-month $103 Put option. This way, he would receive a net premium credit of $20. ($30 premium for selling Put options – $10 premium for purchasing Put options).
On the day of expiry, below scenarios can happen:
Scenario 1: Share price below $103. In this case, both the put options will be in-the-money (ITM). The investor would have to buy 10 shares for $107 each through the put option that he had sold; but he can sell those 10 shares at $103 each through the put option that he has bought. So the investor would make a loss of $4 per share i.e. $40 loss. But the investor had earned a net premium of $20 on the day that he created the Bull Put Spread; so the net loss would be $40 – $20 = $20. This is the maximum loss that can happen.
Scenario 2: Share price between $103 and $107 (let’s say $105). In this case, the $107 put options will be ITM; so the investor will have to buy 10 shares at $107 each from the option-buyer; and he can sell those shares in the market for $105 each so the investor will make a loss of $2 per share i.e. $20 loss. But since he had earned a net premium of $20 on the day of creating the Bull Put Spread; his net loss would be $20 – $20 = 0 i.e. No Profit No Loss.
Scenario 3: Share price above $107. This is the best-case scenario for the investor as both options would be out-of-money; and the investor can safely keep the full premium of $20; he had earned it on the first day of entering into the Bull Put Spread. Net Profit is $20. This is the maximum profit that the investor can make in this example.
Conclusion
This strategy provides the investors an opportunity to make money in a bullish stock market; when he is expecting the prices to move upward.
Using a Bull Put Spread Strategy; an investor can earn money from the net premium received on the first day of creation of the spread. The maximum loss that can happen in any scenario is limited and known to the investor on the day of entering into the strategy. Additionally, the maximum profit potential is also limited and it is the net premium received on day 1.
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