What is a Bull Put Spread?

//What is a Bull Put Spread?
What is a Bull Put Spread? 2017-10-01T05:46:39+00:00

Definition: A bull put spread is an investment options strategy that requires investors to sell a put option at a specified strike price and buy a put at a lower strike price. In other words, it’s a strategy of buying and selling options to buy stocks based on the stock price speculation.

What Does Bull Put Spread Mean?

What is the definition of bull put spread? A bull put spread has the same maturity for both legs and investors earn on the difference between the strike price if the stock price rises higher than the strike price of the put that is sold. Generally, a bull put spread is constructed close to maturity because as maturity approaches, the value of the higher strike put will wear away.

To best implement a bull put spread strategy, investors should be sure that the stockprice will not drop to the lower strike put, and that it will remain at the same level or rise higher than the upper strike put to maturity.

Let’s look at an example.

Example

Alan owns 100 shares of a company that trades at $68 per share. He believes that the stock price will remain $68 and that it cannot drop lower than $58 over the next month. How can Alan profit from a BPS?

Alan can sell a $65 put on the stock for $2.00, which makes $130 x 100 shares = $13,000 and buy a $55 put on the stock for $0.80, which makes $44 x 100 = $4,400. The net credit is $2.00 – $0.80 = $1.2 x 100 shares = $120.

If the stock remains at $58 through maturity, the $65 strike put will expire worthlessly, and Alan will lose all the money he spent on the lower strike put.

If the stock drops below $58 through maturity, both the $65 strike put and the $55 strike put will increase in value. The lower strike put will offset the losses Alan will incur if he is obligated to buy back the higher strike put for a higher market price than $65.

Alan will realize a full profit if the higher strike put expires out of the money.

Summary Definition

Define Bull Put Spread: A bull put spread is a strategy used by investors to sell one option while purchasing another at a lower strike price to render the original option worthless and keep the premium.