This intermediate option trading strategy aims to profit from a neutral to slightly bullish price action in the underlying stock.
A bull put spread consists of one short put at a higher strike price and one long put at a lower strike price.
Both puts have the same underlying stock and the same expiration date.
A bull put spread is established for a net credit (or net amount received) and profits from either a rising stock price or from time erosion or from both.
Potential profit is limited to the net premium received less commissions and potential loss is limited if the stock price falls below the strike price of the long put.
Maximum profit
Potential profit is limited to the net premium received less commissions.
This profit is realized if the stock price is at or above the strike price of the short put (higher strike) at expiration and both puts expire worthless.
Maximum risk
The maximum risk is equal to the difference between the strike prices minus the net credit received including commissions.
In the example above, the difference between the strike prices is 5.00 (100.00 – 95.00 = 5.00), and the net credit is 1.90 (3.20 – 1.30 = 1.90). The maximum risk, therefore, is 3.10 (5.00 – 1.90 = 3.10) per share less commissions.
This maximum risk is realized if the stock price is at or below the strike price of the long put at expiration.
Short puts are generally assigned at expiration when the stock price is below the strike price. However, there is a possibility of early assignment.
Breakeven stock price at expiration
Strike price of short put (higher strike) minus net premium received.
Appropriate market forecast
A bull put spread earns the maximum profit when the price of the underlying stock is above the strike price of the short put (higher strike price) at expiration.
Therefore, the ideal forecast is “neutral to bullish price action.”
Strategy discussion
The bull put spreads is a strategy that “collects option premium and limits risk at the same time.”
They profit from both time decay and rising stock prices.
A bull put spread is the strategy of choice when the forecast is for neutral to rising prices and there is a desire to limit risk.
Impact of stock price change
A bull put spread benefits when the underlying price rises and is hurt when it falls.
This means that the position has a “net positive delta.”
Delta estimates how much an option price will change as the stock price changes, and the change in option price is generally less than dollar-for-dollar with the change in stock price.
Also, because a bull put spread consists of one short put and one long put, the net delta changes very little as the stock price changes and time to expiration is unchanged.
In the language of options, this is a “near-zero gamma.” Gamma estimates how much the delta of a position changes as the stock price changes.
Impact of change in volatility
Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices.
As volatility rises, option prices tend to rise if other factors such as stock price and time to expiration remain constant.
Since a bull put spread consists of one short put and one long put, the price of a bull put spread changes very little when volatility changes and other factors remain constant.
In the language of options, this is a “near-zero vega.” Vega estimates how much an option price changes as the level of volatility changes and other factors are unchanged.
Impact of time
The time value portion of an option’s total price decreases as expiration approaches.
This is known as time erosion.
Since a bull put spread consists of one short put and one long put, the sensitivity to time erosion depends on the relationship of the stock price to the strike prices of the spread.
If the stock price is “close to” or above the strike price of the short put (higher strike price), then the price of the bull put spread decreases (and makes money) with passing of time.
This happens because the short put is closest to the money and erodes faster than the long put.
However, if the stock price is “close to” or below the strike price of the long put (lower strike price), then the price of the bull put spread increases (and loses money) with passing time.
This happens because the long put is now closer to the money and erodes faster than the short put.
If the stock price is half-way between the strike prices, then time erosion has little effect on the price of a bull put spread, because both the short put and the long put erode at approximately the same rate.