What is a 'Bull Put Spread'
A bull put spread is an options strategy that is used when the investor expects a moderate rise in the price of the underlying asset. This strategy is constructed by purchasing one put option while simultaneously selling another put option with a higher strike price. The goal of this strategy is realized when the price of the underlying stays above the higher strike price, which causes the short option to expire worthless, resulting in the trader keeping the premium.
BREAKING DOWN 'Bull Put Spread'In a bull put spread, the investor is obligated to purchase the underlying stock at the higher strike price if the short put option is exercised. Additionally, if exercising the long put option is favorable, the investor has the right to sell the underlying stock at the lower strike price. This type of strategy (buying one option and selling another with a higher strike price) is known as a credit spread, because the amount received by selling the put option with a higher strike is more than enough to cover the cost of purchasing the put with the lower strike.
Profit and Loss
The bull put spread strategy has limited risk, but it has a limited profit potential. Investors who are bullish on an underlying stock could use a bull put spread to generate income with limited downside. The maximum possible profit using this strategy is equal to the difference between the amount received from the short put and the amount used to pay for the long put. The maximum loss a trader can incur when using this strategy is equal to the difference between the strike prices and the net credit received. Bull put spreads can be created with in-the-money or out-of-the-money put options, all with the same expiration date.
Bull Put Spread Example
Assume an investor is bullish on hypothetical stock TJM over the next two weeks, but the investor does not have enough capital to purchase shares of the stock. The stock is currently trading at $60 per share. Consequently, the investor implements a bull put spread by writing five put options with a strike price of $65 for $8.25 and purchasing five put options with a strike price of $55 for $1.50, which are expire in two weeks.
Therefore, the investor's maximum profit is limited to $3,375, or ($8.25 - $1.50) * 5 * 100, since equity options typically have a multiplier of 100. The investor's maximum loss is capped at $1,625, or ($65 - $55 - ($8.25 - $1.50)) * 5 * 100. Therefore, the investor is looking the stock to close above $65 per share on the expiration, which would be the point the maximum profit is achieved.