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 writing another put option with a higher strike price. The combination results in the trader receiving a credit or income from the premium received. The goal of this strategy is realized when the price of the underlying moves or stays above the higher strike price. This causes the written option to expire worthless, resulting in the trader keeping the premium. The risk of the strategy is limited by the bought put option.
Breaking Down the Bull Put Spread
A bull put spread obliges an investor to purchase the underlying stock at the higher strike price if the written 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 is known as a credit spread because the amount received from 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 also 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 written 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. Both options have the same expiration date.
Bull Put Spread Example
Assume an investor is bullish on hypothetical stock XYZ over the next month. The stock is currently trading at $275 per share. Consequently, the investor implements a bull put spread by writing one put option with a strike price of $280 for $8.50 and purchasing one put option with a strike price of $270 for $2, which both expire in one month.
The investor's maximum profit is limited to $650, or ($8.50 - $2) x 1 contract x 100 shares. The investor's maximum loss is capped at $350, or ($280 - $270 - ($8.50 - $2)) x 1 contract x 100 shares. Therefore, the investor is looking for the stock to close above $280 per share on the expiration, which would be the point the maximum profit is achieved.