STOCK MARKET
OPTIONS TRADING STRATEGIES
STRATEGY 18 : BEAR PUT SPREAD STRATEGY: BUY PUT, SELL PUT

This strategy requires the investor to buy an in-the-money (higher) put option and sell an out-of-the-money (lower) put option on the same stock with the same expiration date. This strategy creates a net debit for the investor. The net effect of the strategy is to bring down the cost and raise the breakeven on buying a Put (Long Put). The strategy needs a Bearish outlook since the investor will make money only when the stock price / index falls. The bought Puts will have the effect of capping the investor’s downside. While the Puts sold will reduce the investors costs, risk and raise breakeven point (from Put exercise point of view). If the stock price closes below the out-of-the-money (lower) put option strike price on the expiration date, then the investor reaches maximum profits. If the stock price increases above the in-the-money (higher) put option strike price at the expiration date, then the investor has a maximum loss potential of the net debit.

When to use: When you are moderately bearish on market direction

Risk: Limited to the net amount paid for the spread. i.e. the premium paid for long position less premium received for short position.

Reward: Limited to the difference between the two strike prices minus the net premium paid for the position.

Break Even Point: Strike Price of Long Put – Net Premium Paid

Example: Nifty is presently at 2694. Mr. XYZ expects Nifty to fall. He buys one Nifty ITM Put with a strike price Rs. 2800 at a premium of Rs. 132 and sells one Nifty OTM Put with strike price Rs. 2600 at a premium Rs. 52.

The Bear Put Spread Strategy has raised the breakeven point (if only the Rs. 2800 strike price Put was purchased the breakeven point would have been Rs. 2668), reduced the cost of the trade (if only the Rs. 2800 strike price Put was purchased the cost of the trade would have been Rs. 132), reduced the loss on the trade (if only the Rs. 2800 strike price Put was purchased the loss would have been Rs. 132 i.e. the premium of the Put purchased). However, the strategy also has limited gains and is therefore ideal when markets are moderately bearish.