Bull Put Spread

Bull put spread, also called short put spread or credit put spread, consists of a short put option with higher strike price and a long put option with lower strike and same expiration. The “short” in the name refers to the short position in the more valuable, higher strike put option – not to exposure to underlying direction, which is bullish (profits when underlying price grows).

The strategy is one of vertical spreads and the inverse (the other side) of bear put spread. It has limited risk (equal to strike difference minus net premium received) and limited profit potential (equal to net premium received).

Setup

To create a bull put spread:

  1. Sell a put option (more on strike selection below).
  2. Buy a put option with lower strike, on the same underlying, with same expiration date.

Two important things define a bull put spread:

  • Both options have the same expiration date.
  • The long put has lower strike than the short put (otherwise it would be a bear put spread – the inverse strategy).

Cash Flow

Bull put spread is a credit strategy. When opening the position, cash flow is positive, because the higher strike put being sold is more expensive than the lower strike put being bought as hedge.

Initial CF = short higher strike put price – long lower strike put price

Payoff at Expiration

There are three possible scenarios at expiration. They are the same as with bear put spread, only with the sign reversed (the positions are opposite sides of one another).

Maximum Loss

The worst case scenario is when underlying price ends up at or below the lower strike. The short higher strike put is in the money, resulting in negative payoff equal to higher strike minus underlying price. With underlying also below the lower strike, it is partially offset by positive payoff from the long put, equal to lower strike minus underlying price. Net negative payoff at expiration is therefore equal to strike difference. It is greater than net premium received when the position was opened, so total result is a loss.

Maximum Profit

Maximum profit from a bull put spread occurs when underlying price ends up at or above the higher strike. Both put options expire worthless, so payoff at expiration is zero. We keep the net premium received when position was opened, which is the total profit.

Break-Even Point

If underlying price ends up between the strikes, the result is either profit or loss. The break-even point is the same as with the inverse bear put spread – the underlying price where (now negative) payoff from the higher strike put is equal to net premium received.

Short put payoff = net premium received

Higher strike – B/E underlying price = net premium received

B/E = higher strike – net premium received

Unlike bear put spread, bull put spread is profitable above the break-even, and loses money below.

For more details and examples of payoff calculation, see Bull Put Spread Payoff, Break-Even and R/R.

When to Trade

Bull put spread is a suitable strategy when we expect the underlying price to moderately decrease, or at least not rise. The position can be constructed with long, short, or neutral volatility exposure, depending on strike selection.

Strike Selection

We can break down the strike selection decision in two parts:

  1. Where = Which strikes relative to current underlying price.
  2. How wide = How big distance between the two strikes.

With the first decision we have three possibilities:

  1. Both strikes below current underlying price (out of the money).
  2. Both strikes above (in the money).
  3. Long strike above (ITM) and short strike below (OTM).

The logic is similar to bear put spread – only all the exposures are opposite, because the two strategies are inverse of one another.

Both Strikes below Underlying Price

If we open a bull put spread with both strikes below the current underlying price, both put options are out of the money and relatively cheap. Net premium received (and therefore maximum possible profit) is smaller, as the difference in option premiums is also smaller.

That said, we don’t have to rely on underlying price to move for the position to become profitable. As time passes, if the underlying does not move (or if it goes up), both options’ time value erodes, but the short higher strike put loses more time value than the long lower strike put – therefore the spread gains value with time – it has positive theta. It also has negative vega (it is short volatility – if the underlying doesn’t move, it is good).

Both Strikes above Underlying Price

The opposite exposure to time and volatility is created when we open a bull put spread with both strikes above current underlying price. Now both options are in the money, their premiums are greater, and also the difference between premiums (net premium received – our maximum possible profit) is bigger.

The bigger profit potential is offset with the less favorable starting position. With both options in the money, we need underlying price to increase for our position to become profitable. Unlike the previous case, if the market doesn’t move until expiration, the trade will result in a loss (equal to strike difference minus net premium received). Now we need volatility (positive vega), while time works against us (negative theta).

Underlying Price between Strikes

Sometimes we don’t want any exposure to volatility – we just use the strategy to speculate on underlying direction. When we choose the higher strike above and the lower strike below current underlying price, and both strikes have approximately the same distance from it, the spread will have both theta and vega close to zero. Both options will have approximately the same time value (the short higher strike put will be more expensive overall, but a portion of its premium is intrinsic value which does not decay with time).

To create a volatility neutral bull call spread, choose two strikes with underlying price in the middle. The exposures to time and volatility may still become positive or negative as underlying price moves, and we may choose to adjust the position to keep it neutral.

Strike Distance

Besides the position of strikes relative to underlying price, the spread’s risk and return profile is affected by the distance between strikes. If they are close together, the long and short put options are more similar, and the strategy is less risky, but also potentially less profitable. With the strikes further apart, both risk and profit potential are greater.

Summary

  • If you expect price to not fall, not necessarily to rise, choose lower strikes. Time is on your side.
  • If you expect price to rise, possibly with increased volatility, choose higher strikes. Time is against you.
  • If you want the position neutral on time and volatility, choose the higher strike above and the lower strike below current underlying price, about the same distance.
  • If you are conservative, choose strikes close together.
  • If you can risk more, and want more profit potential, choose strikes further apart.

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