Short Put Spread (Bull Put Spread)
Overview
Looking to make money when stocks go up (or even just sideways), but don't want to risk too much? The Bull Put Spread might be your new favorite strategy. It's like getting paid to bet that a stock won't fall below a certain level – and even if you're wrong, your losses are capped.
Here's the deal: you sell a put option at one strike price and simultaneously buy a cheaper put option at a lower strike price (with the same expiration date). The put you sell brings in premium (that's cash in your pocket right away), while the put you buy acts as your safety net, limiting your downside if the stock decides to tank against your expectations.
Key Characteristics
- Market Outlook: "I think this stock is heading up or at least won't drop below my short strike"
- Risk: Limited to the difference between your strike prices minus what you collected upfront
- Profit Potential: Limited to the premium you collect when setting up the trade
- Breakeven Point: Higher strike price minus the net premium you received
When to Use
The Bull Put Spread might be your strategy of choice when:
- You're feeling bullish but don't want to go all-in on a stock purchase
- You want to generate some income in a flat or rising market
- You'd like a higher probability of winning than with many directional strategies
- Options premiums are juicy due to high volatility (more premium = more potential profit)
- You want to put on a bullish trade with defined risk and a clear exit strategy
Real-World Example
Let's walk through this with a concrete example. Say XYZ stock is trading at $50, and you think it's a solid company that's likely to stay above $45 over the next month.
- You sell a $45 strike put option expiring in a month and collect $2 per share ($200 total)
- To protect yourself, you buy a $40 strike put option expiring on the same date for $0.75 per share ($75 total)
- Your net credit is $1.25 per share ($125 total) – that's cash in your account immediately
- Your maximum risk is $3.75 per share ($375 total): the $5 spread width minus your $1.25 credit
Now let's see what happens in different scenarios:
- Best case: XYZ stays above $45 by expiration. Both options expire worthless, and you keep your entire $125 premium. That's a 33% return on your risk in just a month!
- Middle case: XYZ drops to $44 at expiration. Your short $45 put is $1 in-the-money, costing you $100, but you still keep $25 of your original premium.
- Worst case: XYZ crashes below $40. You lose the maximum $375 (the $5 spread between strikes minus your $1.25 credit). But at least your loss was capped!
The Good Stuff
- You get paid upfront – the premium hits your account immediately
- Your risk is completely defined and limited
- Time is on your side – as expiration approaches, time decay works in your favor
- You can win even if you're not exactly right about direction – the stock can go down slightly and you still profit
- Higher probability of profit than many directional options strategies
The Not-So-Good Stuff
- Your profit is capped at the initial premium you receive (no home runs here)
- Requires more capital to put on than some other strategies due to margin requirements
- The risk/reward ratio isn't always attractive – you might risk $300 to make $100
- If the stock plummets, you'll hit your maximum loss pretty quickly
- You might face early assignment on your short put if the stock drops significantly
Playing It Smart
- Look for strong support levels when choosing your short put strike price
- Consider the width of your spread carefully – wider spreads mean more premium but also more risk
- Be extra cautious around earnings announcements or other major news events
- Don't get greedy – aim for a credit that's at least 1/3 of the width of your spread
- Have an exit plan – consider closing the position if the stock approaches your short strike
- Remember that taking smaller, consistent profits is often better than swinging for the fences
- Only sell puts at strikes where you'd be comfortable owning the stock (just in case)