Bull Put Options Spread Explained (Simple Guide)
How would you like to earn a healthy return from a stock that you think will rise moderately in the near future? You can do that without buying the stock if you trade a bull put spread.
A bull put spread is similar to a short put, except there’s less risk involved.
With a short put, you could take a huge loss if the underlying stock tanks. A bull put spread, on the other hand, hedges your position with the a long put.
In this guide, I’ll explain the bull put spread so you’ll know when and how to trade it.
What Is a Bull Put Spread?
A bull put spread is a two-legged option strategy.
First, you buy one out-of-the-money put option. Then, you sell an in-the-money put option at a higher strike price.
On both sides of the trade, the options will have the same expiration date and the same underlying stock.
The result of the bull put spread is a net credit to your account. That means you receive money.
Why? Because the sale of the in-the-money option earns you more than the cost of the out-of-the-money option.
When Would You Use a Bull Put Spread?
Use a bull put spread when you think the underlying stock will increase in price but not increase too much.
Your profit is limited with the spread. So if the stock skyrockets, you can’t take advantage of the run-up. You’ll have to settle for a much lower return.
If you’re completely wrong and the stock tanks, you’ll lose money on the trade. The maximum amount you can lose is the difference between the two strike prices minus the amount of the credit you received.
In that case, though, the amount you lose will be less than the amount you would have lost if you had just sold a put option.
How Does a Bull Put Spread Work?
First, make sure that your trading platform supports multi-leg orders. As noted above, you’ll need to place two orders simultaneously with a bull put spread. Finding the right broker is crucial.
Next, identify a stock that you think will rise modestly in the near future. Then, take a look at its options chains.
Specifically, look at the put options. Find one with a strike price that’s equal to your target price for the stock. It should be out of the money.
An out of the money put option is one in which the price of the underlying stock is more than the strike price of the option.
That option is the one that you’ll buy. Next, you need to find one that you’ll sell to complete the spread.
To do that, look for a put option with a strike price lower than the other one.
That option, by the way, should be in the money. That means the stock price is lower than the strike price.
After you’ve identified the options for both ends of the trade, go ahead and place the multi-leg order. Then, monitor the results to see if your trade turns profitable.
Real Life Example Using a Bull Put Spread
There are various screening tools that can help you pinpoint options opportunities.
Let’s say that Twitter (NYSE: TWTR) is currently trading for $32.50 per share. You think it’s oversold and will rise in the near future; you’d like to make some money with a bull put spread.
Your target price for the stock is $34, so that’s the strike price you’re looking for as you check out next month’s options chains. You see that the $34 put option is currently bid at $3.15.
That’s the option you’ll sell.
Now, you need to complete the spread by purchasing a put option with a lower strike price. You see that the in-the-money $32.00 option is currently offered at $2.50.
After further research, you determine that the options prices are fair, so you decide to place the trade.
You start by selling the $34 put option for $3.10. Remember, though, that options are sold in batches of 100 shares so that earns you $310 ($3.10 x 100 = $310).
Next, you buy the lower-priced, out-of-the-money put option. That costs $250 ($2.50 x 100 = $250).
Your total credit for the whole transaction is $60 ($310 – $250 = $60). That’s also your maximum gain.
After a month, it turns out that your prediction was accurate. Twitter shoots up to $34.33 per share at contract expiration.
In that case, both options expire worthless and you keep the $60 you earned from placing the spread.
But what happens if the stock moves in the other direction?
Let’s say it drops to $31 per share at expiration. You’ll have to buy back the put option that you sold. That will cost you $300.
However, the $32 put option that you bought will be worth $100. You’ll sell that for a loss of $150 ($250 – $100 = $150).
Your total loss for the whole spread will be $140 ($300 – $100 -$60).
That’s also your maximum loss for the trade. No matter how low the stock goes, you’ll never lose more than $140 (not including commissions).
What Are Similar Strategies Related to a Bull Put Spread?
The following strategies are similar to a bull put spread:
- Bull Call Spread – A bullish spread that uses call options instead of put options.
- Bear Put Spread – A spread strategy that turns profitable when there’s a modest decrease, instead of a modest increase, in the underlying stock price.
- Short Put – The same thing as a bull put spread except that it doesn’t involve buying a put option. It’s a much riskier trade.
Bull Put Spread Compared to Other Options Strategies
Like many other options strategies, the bull put spread limits both your risk and your return. That’s because you hedge yourself by selling one option while buying another.
If you’re really bullish on a stock, you could opt to trade a short put. There’s quite a bit of risk associated with that trade, though. You’ll see a high percentage loss if that stock plummets.
You’ll also likely need significant margin on hand if you want to play a solo short put.
Advantages & Risks of a Bull Put Spread
- Limited risk – Because there’s a short and long side to the spread, your risk is limited. Your maximum risk is capped at the difference between the two strike prices minus the credit you received from placing the order.
- Immediate credit – You get an immediate credit with a bull put spread. That credit is also your maximum return.
- Limited return – You can’t “let your winners run” with a bull put spread. That’s because your profit is limited if the stock soars.
- Significant loss possible – On a percentage basis, you can lose a lot of money with a bull put spread that goes the wrong way. Be cautious about getting too exuberant with spreads.