How To Trade A Bull Put Spread

bull-put-spread

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Buying stocks isn’t the only way to make money when the stock market is rising. An alternative trading strategy is to place bull put spreads that can profit when stocks rise or even when they remain flat.

Bull puts are a wager that stocks won’t crash lower by a fixed time. If you feel pretty comfortable that a share price will meander sideways or increase, these credit spread options strategies have the potential to produce cash flow regularly.

They are also a less risky way of betting on a share price than naked puts, which expose options traders to much greater loss potential when stocks fall.

And compared to buying stocks, which requires a hefty upfront capital investment, bull put spreads pay out a fixed amount at the start of each trade in exchange for taking on a certain level of risk, which can be much smaller than the risk of owning stocks.

So how do you trade a bull put options spread?

>> Back up, teach me options trading basics first

How To Make Money When Stocks Rise: Bull Put Spread

Bull put spreads are labeled vertical options spreads because higher strike put options are sold in the same expiration month as lower strike put options are bought.

The put options sold produce a larger credit than the puts purchased cost, meaning that bull put spreads are defined as credit spreads.

Options spreads that put money in your pocket are known as credit spreads while spread trades that require you to take money out of your pocket are known as debit spreads.

What makes credit spreads attractive is that they require little or no stock movement to profit. In fact, if a share price flatlines, these options spreads can still produce cash flow. And if a share price moves as expected, they can make money more quickly.

In the case of a bull put spread, a rising share price will make money faster than a meandering share price but both will lead to profits by options expiration.

The only trend that works against a bull put spread is a strong bearish trend. Even when a share price falls slightly, a bull put spread can end up making money by expiration, as long as the share price remains above the strike price of any put options sold.

Time erodes the value of credit spreads and time-decay accelerates over the final 30 days of an option’s life so a rule of thumb is to place bull put spreads near expiration, ideally with no more than 30 → 45 days.

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What Is A Bull Put Spread?

Bull put spreads are constructed by:

  1. Selling higher strike price put options
  2. Buying lower strike price put options
TypeBuySell
CallBullishBearish
PutBearishBullish

When you get paid to sell puts – known as short puts – you are making a bet that a stock will not fall lower.

In contrast, buying puts is a bet that share prices will decline. These puts are labeled long puts, meaning that you need to spend money to purchase them.

A bull put spread at first glance may appear to be a riddle because, on the one hand, you are taking a bullish stance and on the other you are taking a bearish view. It would seem as if they should offset each other?

In practice, options prices are affected by factors called The Greeks. And one of those Greeks is called delta, which tells you how much an option moves when a stock moves.

In a bull put spread, the short put makes more money when a share price rises than the long put loses. Plus, the short put generates more income than the long put costs, so whether a share price rises or moves sideways the strategy may profit.

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WHAT IS THE DELTA OF AN OPTION?

Imagine you place a bull put spread whereby the put you sell has a delta of 0.50 and the put you buy has a delta of -0.20.

When the share price rises $1, the put you sell makes $0.50 while the put you buy loses $0.20.

The net result is that you make $0.50 and lose $0.20, resulting in a $0.30 gain overall.

It works in reverse too, so if the share price fell by $1, you would lose $0.30.

What makes bull put spreads attractive is that the maximum risk in a trade may be $4 per share so a $0.30 gain translates to a 7.5% profit ($0.30 / $4.00).

Compare that gain to the percentage profit from buying stock and you can see what makes bull puts so alluring.

For example, if you bought a stock for $100 per share and it went up by $1 to $101, the gain is just 1% which is not bad but nowhere close to the 7.5% gain possible from entering the bull put.

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How To Place A Bull Put Spread

To place a bull put spread, the following orders would be executed in your brokerage account.

Option TypeActionStrike PriceExpiration
Short PutSell To OpenHigherSame month
Long PutBuy To OpenLowerSame month

All the best options trading brokers support bull put spreads, so whether you trade at thinkorswim or tastyworks you will be in good hands.

TASTYWORKS SPOTLIGHT
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  • Commissions: All closing trades are commission-free
  • Account Balance Minimum: $0
  • Commissions: $5 flat rate for stocks; $1 per contract for options to open

via tastyworks secure site

The goal when placing a credit spread, like a bull put spread, is to hold the position until time-decay has taken full effect and eroded the value of the options fully.

When the underlying stock rises quickly, put values usually decline in price quickly – the ideal outcome.

However, a slow-moving share price will mean that put options will often hold their value all the way up to the options expiration date, after which they expire worthless.

HOW TO START AND END A BULL PUT OPTIONS SPREAD

To get started with a bull put spread, enter a Sell To Open order for the number of short put contracts you plan to sell and, at the same time, a Buy To Open order for the same number of long put contracts you wish to buy.

Unlike a debit spread, which requires you to place closing orders, a credit spread generates maximum profit when both options expire worthless.

However if you were to close the position early, you would place a Buy To Close order for the short put contracts and a Sell to Close order for the long put contracts.

On most of the top options trading platforms, these two orders can be executed simultaneously.

>> Caution: If you enter more short put contracts than long put contracts, the additional short puts will be treated as naked puts by your broker, and subject to larger margin requirements.

Bull Put Spread Risk Graph Example

You might be wondering at this stage how much money you would make or lose when you place a bull put spread if a share price were to rise or fall. Let’s take a look with this bull put spread example.

Assume the share price is $70.

The put you sell is at a strike price of $70 while the put you buy has a $60 strike price.

When you sell the higher strike price put, you will receive its Bid price and when you buy the lower strike price put, you will pay its Ask price.

Short Put Bid Price = $5
Long Put Ask Price = $2

Bull Put Spread Credit = $5 – $2 = $3

No matter how high the stock rises, the most you can ever make is $3 while the most you can ever lose is $7 (the difference between the strike prices, $10, minus the credit of $3)

BULL PUT RISK GRAPH

Stock PriceLong Put ProfitShort Put ProfitBull Put Profit
$40$1800-$2500-$700
$50$800-$1500-$700
$60-$200-$500-$700
$63-$200-$200-$400
$65-$200$0-$200
$70-$200$500$300
$80-$200$500$300
$90-$200$500$300

Anywhere above $70 per share at options expiration, the bull put earns its maximum profit.

Below that level, it runs into trouble. At $67, the bull put spread is at its breakeven level excluding commissions and fees while below that it starts to show a loss.

The breakeven level is $70 –  $3 = $67

The most money that can be lost in a bull put spread is $7 per share or $700 per contract, which is calculated as the difference between the strike prices minus the credit.

If the stock falls to zero, this is still the most the can be lost. And equally if the share price doubled or galloped even higher, the profit would still be limited to $3 per share or $300 per contract.

The maximum profit potential in a bull put spread is calculated as follows:

Maximum Profit = Short Put Credit – Long Put Debit

Bull Put Spread Payoff = [$5 – $2] = $3

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Bull Put Spread Tips

TIME DECAY IS YOUR FRIEND

Like other credit spreads, bull put spreads are best applied over short time durations to maximize the effects of time-decay.

Ideally, you want both options to expire worthless. By holding the options through to the expiration date, you can enjoy maximum profits.

If you were to place the long and short puts further out in time, the effects of time-decay would be much more muted so profits would be earned more slowly – all else being equal.

As a result, the general rule of thumb is to place bull put spreads no more than 30 → 45 days from expiration.

None of these rules are fixed and it’s always advisable to play around with the strategy on a virtual trading platform or simulator before getting started in earnest with real money.

KEEP BID-ASK SPREAD LOW

In our bull put spread example above we used whole numbers to make the calculations easy.

In practice, a bid-ask spread exists which is the difference in price between what you can buy and sell the option.

Sometimes the bid-ask spread is large, especially on stocks with options chains that have poor liquidity.

If you are trading a bull put spread on a stock with wide bid-ask spreads, you will need to factor in the costs of slippage in case you need to exit the position.

Sometimes, slippage or the difference between bid and ask prices is significant and can make a big difference to the profitability of a trade, or lack thereof.

USE IDENTICAL CONTRACT NUMBERS

When you place a vertical credit spread, it is best to enter the same number of short and long options.

If you were to place more short puts than long puts, the additional short puts would be considered naked, so the risk in the trade would be much higher.

Or if you placed more long puts than short puts, the profit potential in the trade may be significantly impacted. This type of trade is called a ratio put backspread.

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EXPIRATION MONTHS SHOULD BE IDENTICAL

Another options tip is to keep the expiration months for both short puts and long puts identical.

When the months and strikes differ, the strategy is labeled a diagonal options spread and it has a different reward-to-risk profile than a vertical spread.

THE WORST CASE OUTCOME

When you enter a bull put spread, the worst case outcome is that the share price plummets during the time when you are holding the position.

To limit the risk of this, bull put spreads are often best avoided during times of expected volatility, such as earnings announcements.

Because earnings are announced quarterly for most companies, bull put spreads are often best placed in the months following earnings reports.

When Should You Trade A Bull Put Spread?

Bull puts are applied when you have a moderately bullish outlook.

However, a share price that rockets higher will lead to even faster profits for the spread trade strategy.

Even if the share price falls but doesn’t move below the short put strike price upon expiration, you should still enjoy the full profit potential.

Only a bearish move below below breakeven will lead to losses upon expiration.

Sometimes a combination of a volatility spike or wide bid-ask spreads could make it appear as if the spread is losing money.

You will need the effects of time-decay to erode the options value and overcome these hurdles in order to profit so the position largely relies on having patience and a fairly stable or rising share price.

Best Stocks For Bull Put Spreads

BULLISH OR FLAT STOCKS

Stocks that are rising or moving sideways are usually good candidates for a bull put spread.

If a share price is choppy you may be able to earn more premium from a bull put spread but the risk of losing money increases too.

LIQUID STOCKS & OPTIONS

Low-priced stocks and penny stocks that don’t have options or have options with wide bid-ask spreads are usually poor candidates for bull put spread strategies because put premiums are not sufficient to warrant trade entry.

BE WARY OF COMPANY ANNOUNCEMENTS

In addition to earnings, be wary of company announcements that could lead to significant share price volatility.

For example, a company announcing the departure of a new CEO, a new product, or a regulatory approval may display more volatility.

Have you traded bull put options spreads? How did they work out for you? We would love to hear from you in the comments below.

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