Bull Put Spread

What is bull put spread？

This strategy can be broken down into three parts: bull, put, and spread.

Bull: This indicates a belief that the price of the underlying asset will rise.

Put: This refers to the type of options used in the strategy.

Spread: This involves buying and selling multiple options of the same type (in this case, puts) on the same underlying asset, typically with different strike prices or expiration dates.

Practical Scenarios

● Expect the stock price to rise but not by much.

● Already sold a put option and would like to reduce the risk by buying an out of the money put.

I. Strategy Explained

1) Setup

「Buy Put A」 + 「Sell Put B」

Strike Price of Put A < Strike Price of Put B

Note: We label the options with uppercase letters for clarity. The strike price of Put A is lower than that of Put B.

2) Breakdown

Potential profit：

Sell Put B: You may profit if the underlying stock does not fall.

Buy Put A: This reduces the risk of selling Put B.

3) Features of Strategy

Favorable conditions: Best suited for a mildly bullish outlook where the underlying stock price is expected to stay flat or rise slightly.

Limited Profit: Maximum profit is capped due to the higher strike price of Put B (the sold put).

Theoretical Maximum Profit: Net Premium Per Share × Multiplier × Contract Quantity

Limited Loss: Owning Put A (the purchased put with a lower strike price) limits your loss.

Theoretical Maximum Loss: (Put B Strike Price − Put A Strike Price− Net Premium Per Share) × Multiplier × Contract Quantity

Option Selling Strategy: The primary trading position in this strategy is short put B, which potentially generates profits if the stock rises as expected.

This is a capped-profit bullish selling option strategy with a limited risk. Ideally, it should be considered when implied volatility is high and may benefit even if the stock price is sideways or oscillating.

Lower Initial Cost: The premium received from selling Put B is higher than the premium paid for buying Put A, resulting in an initial net credit.

II. Case Study

TUTU is a publicly traded company focusing on the artificial intelligence. You believe that TUTU's stock price will rise in the future. By observing the candlestick charts, you believe the stock price will be above $58 at expiration. Consequently, you decide to sell a put option with a strike price of $58.

Given the high risk associated with being an option seller, to reduce the risk of selling the put, you also buy a put with a strike price of $50. This setup forms a bull put spread strategy.

If the stock price falls, the purchased put A provides some protection for the sold put B.

If the stock price rises, you may profit from the net premium received.

Profit from opening the position:

Premium paid for put A: -$200 (-$2 per share).

Premium received from put B: $500 ($5 per share).

Net premium in total: -$200 +$500=$300 ($3 per share).

1) Scenario 1: Stock price is above put B strike price at expiration

Both put A and put B are OTM and expire worthless.

The maximum profit is achieved, which is the net premium received when opening the position.

Maximum Profit (Theoretical): Net Premium per Share * Multiplier * Contract quantity = (-$2+$5)*100*1=$300

Note: The profit for this strategy is limited. Even if TUTU's stock price rises to $100, the maximum profit is still $300.

2) Scenario 2: Stock price is between put A strike price and put B strike price at expiration

Breakeven: Put B Strike Price - Net Premium Per Share = $58-$3=$55.

If the stock price is below $55, the strategy suffers loss and the loss is limited.

If the stock price is above $55, the strategy may profit and the profit is limited.

3) Scenario 3: Stock price is below put A strike price at expiration

Both put A and put B are ITM and maximum loss is achieved in this case.

Maximum Loss (Theoretical): (Put B strike price - Put A strike price - Net premium per share) * Multiplier * Contract quantity

Note: In a bull put spread, net premium is often positive (cash inflow).

Put A exercised: you can sell 100 shares of TUTU for $50 per share.

Put B assigned: you need to buy 100 shares of TUTU at $58 per share.

During this process, you will lose $8 per share.

But don't forget: there was a $3 per share net premium inflow incurred when opening the position.

Since the multiplier is 100, the total loss is (-$8+$3)*100*1=-$500.

Note: The loss for this strategy is limited. Even if TUTU's stock price falls to $0, the theoretical maximum loss is still -$500.

Maximum potential loss and profit for options are calculated based on the single leg or an entire multi-leg trade remaining intact until expiration with no option contracts being exercised or assigned. These figures do not account for a portion of a multi-leg strategy being changed or removed or the trader assuming a short or long position in the underlying stock at or before expiration. Therefore, it is possible to lose more than the theoretical max loss of a strategy.

III. How to construct a bull put spread on Futubull

IV. Applying the bull put spread strategy

1) Expect the underlying stock price to rise, but with limited upside

Investors often base their strategies on short-term price trends. If these trends change or fade quickly, the original spread strategy may become ineffective. Therefore, a bull put spread is generally better suited for short-term speculation rather than long-term investment.

If an investor expects the stock price to stay within a certain range in a specific time frame, they can buy Put A and sell Put B. This approach allows them to benefit from a potential stock price increase while limiting the risk of a price decline compared to holding the underlying stock.

2) Expect the underlying stock price to rise, already sold a put, and want to reduce risk

Expecting the stock price to rise, an investor may sell a put B. To help offset some of the high risk for put B, buy a put A with a low strike price.

From this perspective: If an investor expects the underlying stock price to increase, they can create a bull put spread by selling an ATM put B and buying an OTM put A. This strategy allows them to potentially profit from the stock's rise while reducing the risk of selling put B.

V. FAQs

Q: Choosing the strike price?

A:

Conservative: More conservative investors may buy and sell both out-of-the-money puts. In this way, there is a higher probability the options will expire OTM, but this also causes a lower initial premium inflow.

Moderate: Moderate investors may buy an out-of-the-money put and sell an in-the-money put, taking on additional level of risk in exchange for potentially moderate returns.

Aggressive: More aggressive investors may buy and sell both in-the-money puts. Such a combination can generate higher returns potentially, but there's a lower probability the options will be out-of-the-money by expiration.

Q: Evaluating the bull put spread position in different scenarios?

A:

Scenario 1: When the stock price drops below put A strike price or rises above put B strike price

Both options will be either in-the-money (ITM) or out-of-the-money (OTM) simultaneously. This indicates that the strategy has reached either its theoretical maximum loss or maximum profit.

In this case, investors can choose to hold the position until expiration. Whether suffering the loss or gaining the profit, Futu will automatically liquidate the options upon expiration.

Scenario 2: When put A strike price < stock price < put B strike price

Evaluate the risk of put B being assigned early. If the risk is high, and a stock position is not wanted, then consider these two methods:

Method 1: Sell to close the put A position and buy to close the put B position. Exit the bull put spread strategy by closing both options in the strategy.

Method 2: Buy to close the put B position. Although this may incur a high closing cost, it avoids the risk of assignment while retaining the profit potential of put A. Remember, if you only close the put A position and leave put B open, it effectively results in a very risky naked short put position.

Scenario 3: Turn a bull put spread into a short put butterfly

If investors have constructed a bull put spread, but the underlying stock experiences significant volatility, and they anticipate that the stock price may continue to oscillate near the resistance level for some time, they may worry that sustained high volatility could lead to a loss in option premium.

To help address this, investors may add a bear put spread below, changing the strategy into a short put butterfly. This adjustment transforms the strategy to be more favorable towards volatility, allowing for profits when there is a significant rise or fall in the stock price.

Scenario 4: Turn a bull put spread into a short diagonal bull put spread

The main difference between a short diagonal bull put spread and a regular bull put spread is the expiration date of the options. In a short diagonal bull put spread, you buy a short-term put option with a lower strike price and sell a long-term put option with a higher strike price, keeping the number of contracts the same.

Investors establish a short diagonal bull put spread in order to get greater net credit than the bull put spread with the same strike price and same expiration date as the short-term put option. If the stock price falls sharply before the short-term expiration, the short diagonal bull put spread may suffer the lower maximum loss than the bull put spread.

However, if the stock price is equal to the strike price of short-term put at short-term expiration, the short diagonal bull put spread will incur a loss, while the bull put spread may realize a profit. The difference mainly comes from the long-term short put in diagonal put spread experienced less time decay than the same strike price, short-term short put in the bull put spread.

Click here to learn more: short diagonal bull put spread

Q: What is the difference between a bull call spread and a bull put spread?

A:

While both strategies aim to profit from a rising market, they differ in their approach and risk profile.

Investors may choose between a bull call spread and a bull put spread based on their expectations of price movements, implied volatility, and risk appetite:

• Bull call spread: If investors are optimistic about the market, have a lower risk tolerance, and the current implied volatility is low, they might opt for a bull call spread. This strategy generally involves buying a call at the current price and selling a higher strike call to potentially profit from a rise in the stock price while reducing the initial cost.

• Bull put spread: If investors are moderately optimistic or neutral about the market, have a higher risk tolerance, and the current implied volatility is high, they might choose a bull put spread. This generally involves selling a put at the current price and buying a lower strike put. This strategy allows them to collect premium upfront while limiting potential losses if the stock price drops significantly.