Mastering the Bull Put Spread Strategy: A Simple Guide

In options trading, strategy is key to success. Let’s explore a game-interesting tactic — the Bull Put Spread. A Bull Put Spread proves valuable for investors foreseeing a moderate increase in the underlying asset’s price. This strategy involves utilising two put options, establishing a range with a high and low strike price.

What’s a Bull Put Spread?

It’s like a bet on a stock going up, but with a safety net. You sell a put option (like a prediction) at a higher price and buy another put option at a lower price. Both options have the same expiration date.

How Does It Work?

Selling High, Buying Low:

• You sell a put option with a higher price because you think the stock will stay above that price.
• At the same time, you buy a put option with a lower price for added security.

Limited Gains, Limited Loss:

• Your potential profit is the difference between the two prices, minus some costs (Brokerage + Govt. tax + GST)
• But, your potential loss is also capped — it’s the difference between the prices, minus what you earned initially.

When to Execute?

Choose the Bull Put Spread when you’re feeling bullish about a stock. It’s your way of saying, “I bet this stock’s price is going up!” You earn if you’re right, and if not, you’ve got your losses capped.

Why Bullish?

Because you’re hoping the stock goes up. If it does:

• Both options expire without being used.
• You keep the money you earned from selling the put option. It’s a win-win!

Trade Mechanics

Break-even point:

To break even, you take the strike price of the sold put and subtract the net premium received.

Let’s say you sell a Nifty put option with a strike price of 21,800 and receive a net premium of 100. Your breakeven would be 21,800–100 = 21,700.

Maximum Profit:

Your best outcome is when Nifty closes above the sold strike price. Both options become worthless, and you keep the net credit.

If you sold the 21,800 put for 100 and bought the 21,600 put for 50, your maximum profit is 50 (100–50).

Maximum Loss:

Your risk is the difference between the two strikes minus the credit received initially. Maximum loss happens if Nifty closes below the lower strike put (21600 in this case), the maximum loss would be calculated as follows: difference between the strikes (21800–21600 = 200) minus the net credit received (100–50 = 50). Thus, the maximum loss is 150 (200–50).

But, Be Aware

If the stock drops below the lower price, you might lose some money. But remember, your potential loss is limited. So, it’s like saying, “I think this stock will go up, but just in case, let’s be a bit cautious.”

It’s a strategy that limits your risk while allowing for potential gains, making it a thoughtful approach to trading options.

Scenario for Bull Put Spread

The Bull Put Spread, ideal for a modest bullish outlook, involves selling a higher-priced (ITM) Put and buying a lower-priced (OTM) Put for the same expiry. This strategy creates a net credit, as the premium earned from the sold option exceeds the cost of the bought option, allowing flexibility with different strike prices to suit your market view.

To set up a bull put spread, you:

• Buy one Out-of-the-Money (OTM) Put option (leg 1)
• Sell one In-the-Money (ITM) Put option (leg 2)

Make sure:

• All options are for the same stock or index
• They have the same expiration date
• You’re dealing with an equal number of options in each leg

Example Setup:

• Date: 5th February 2024
• Market Outlook: Moderately bullish, expecting an increase
• Nifty Spot Price: 21750

Trade Setup:

• Buy a 21500 PE, paying a premium of Rs.4K (Out-of-the-Money option, debit transaction).
• Sell a 21700 PE, receiving a premium of Rs.6K (In-the-Money option, credit transaction).
• The net cash flow from this setup is Rs.2K (Rs.6K received — Rs.4K paid), resulting in a net credit to your account.

Bull put spreads result in a ‘net credit,’ making them a type of ‘Credit Spread.’

Potential Market Scenarios and Their Impact:

Market Expires Below 21500 (below the lower strike):

• Maximum loss occurs, limited to Rs.6K, considering the worst-case scenario where both options are exercised against you. This represents a -22% change based on the initial net credit scenario.

Market Expires at 21600 (at the breakeven point):

• The position breaks even with a profit of Rs.4K, aligning with the scenario where the market expires exactly at the breakeven point calculated from the setup dynamics.

Market Expires at or Above 21700 (above the higher strike):

• Maximum profit is achieved, equal to the initial net credit of Rs.4K, representing a +14% gain from the initial setup. This is when both options expire worthless, allowing you to keep the initial net credit without any further obligations.

Market Expires at 21500 (specific scenario for detailed loss):

• Here, the intrinsic value adjustments and option exercises lead to a specific loss scenario, detailed as a Rs.6K loss, diverging from the more generic calculations provided earlier.

Impact of Delta on Bull Put Spread:

Imagine the Bull Put Spread as a seesaw. Here’s how it tilts with the changing price of the stock:

Upward Price Movement:

• If the stock price goes up, your Bull Put Spread is happy. It’s like winning a prize. You make a profit because the options’ delta changes favourably with the rising stock price.

Downward Price Movement:

• Now, if the stock price goes down, it’s a bit of a bummer. Your Bull Put Spread might take a hit. The delta of the options shifts, impacting the strategy’s profit or loss.

Think of delta like the weather forecast for your strategy. If it’s sunny (stock going up), your Bull Put Spread is all smiles. If there’s a bit of rain (stock going down), it might need an umbrella. Delta is the factor that tells you whether to bring sunglasses or grab a raincoat for your options strategy adventure!

Time’s Role in Bull Put Spread:

Think of your Bull Put Spread like a delicious cake made up of short and long calls. Now, let’s understand how time plays its part:

Stock Price Dance:

• If the stock prices are playing nice and staying between the strike prices, time erosion (Theta) doesn’t bother your Bull Put Spread much. It’s like the cake holding its shape.

Theta’s Side Note:

• Theta, the time decay thing, doesn’t have a big impact here. Since Bull Put Spread is a net credit strategy, any loss from time decay is pretty much expected from the start.

Delta’s Spotlight:

• Now, pay attention to Delta. It’s the star here. Since this strategy is directional, Delta takes the lead. The way the stock moves becomes the main act, influencing the strategy’s fate.

In simpler terms, time is like the background music. If everything is going as planned (stock prices behaving), the music is sweet. But when it’s not, Delta steps in, stealing the spotlight in this options strategy show!

Volatility’s Influence on Bull Put Spread:

Let’s unravel the mystery of how volatility affects your Bull Put Spread, which is essentially a combo of short and long calls:

Steady Spread Prices:

• When the stock price is playing it cool, not doing anything wild, changes in volatility don’t bother your Bull Put Spread too much. It’s like your spread has its own chill zone.

Vega’s Minor Role:

• Vega, the volatility wizard, doesn’t wave a big wand here. It has a small impact on the Bull Put Spread. If other factors are behaving, Vega is just a background character, not stealing the show.

In simpler terms, when the stock isn’t throwing a party of ups and downs, your Bull Put Spread remains pretty composed. Vega might do a little dance in the background, but it’s not the star of this options strategy show.

Concluding Thoughts:

The Bull Put Spread is a strategic approach for those bullish on the market, offering a balanced blend of risk and reward. It’s an excellent way to harness market upturns with controlled exposure. As always, consider your risk tolerance and market outlook before diving in.

Laabhum Social Trading, your gateway to a dynamic and strategic trading experience. Visit our platform to customize your trading strategy, seamlessly integrated into our user-friendly interface. Benefit from expert insights and robust risk management features, allowing you to confidently take charge of your options trading journey.

*** Disclaimer: The information provided in this article is for educational purposes only. It is not intended as financial advice, and readers are encouraged to seek professional guidance before making any investment decisions.