Bear Put Spread Introduction
Definition - Debit Spread Position
Bear Put Spread Example
Example - Using the CallsAndPuts.com "Bear Put Spread" Data

Option Strategy:            
Bear Put Debit Spread (Vertical Bear Puts)

Investor Sentiment:       
Moderate Bearish Strategy (Small Debit Spread): It's considered a bearish strategy because you profit if the underlying stock price decreases.

Profit Potential:             
This strategy requires the investor to buy an in-the-money put option and sell an out-of-the-money put option on the same stock with the same expiration date.  This is also known as a vertical bear put spread.  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.         

Risks:                              
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.

Drawbacks:                    
Lower risk than strictly buying a put option, but limited profit potential.  Break-even at upper strike price minus net debit.  Maximum profit potential if stock decreases below the out-of-the-money (lower) put option strike price.  Similar to a Bull Call Spread, this strategy is a debit spread position.  That is, the amount of the sale of the put option position brings in less than is needed to purchase the put option position.  

Profit / Loss Summary:
Net Debit = Money received from selling out-of-the-money (OTM) put options - Money paid for buying in-the-money (ITM) put options
Maximum Profit Potential = Difference Between Strike Prices - Net Debit
Maximum Loss Potential = Net Debit

Bear Put Spread Introduction

The Bear Put Spread strategy requires the investor to buy in-the-money (higher) strike price put options while simultaneously selling out-of-the-money (lower) strike price put options on the same underlying stock.  A Bear Put Spread strategy is profitable when the stock price moves below the break-even point: upper strike price minus net debit.  A characteristic of the vertical Bear Put Spread is the put options are sold and bought on the same underlying stock with the same expiration date (this is why it's known as a "vertical spread"). CallsAndPuts.com "Bear Put Spread" data focuses on bear put spread plays that are vertical in nature.  The benefit of the Bear Put Spread strategy is the risk never exceeds the net investment of buying and selling put options simultaneously.  This strategy is considered moderately bearish because the investor is using the the sale of a put to reduce his/her risk while still positioning for a decent profit should the stock price move below the lower put option strike price.  The maximum loss potential is reached if the stock moves above the in-the-money (higher) put option strike price. 

Definition - Debit Spread Position

As previously mentioned, a Bear Put Spread is the purchase of an in-the-money (higher) put option while simultaneously selling an out-of-the money (lower) put option on the same underlying stock.  There are more aggressive and less aggressive Bear Put Spread positions, but CallsAndPuts.com "Bear Put Spread" data looks for plays where one put option position (leg) is in-the-money and the other leg is out-of-the-money on the same underlying stock with the same option expiration date.   That is, there is one strike price above the stock price and one below.  Because the sale of the out-of-the-money (lower) strike price brings in less cash flow than the cost of purchasing an in-the-money (higher) strike price put option, it is considered a "Debit Spread".  To emphasize, if a spread position takes in more through the sale of one put option position than it costs to purchase the other put option position, it is a "credit spread".  If the opposite were true, that is the put buy position costs more than the sale of the other put position, this is known as a "debit spread".  This is the type of position (a debit spread) you see with Bull Call Spreads and Bear Put Spreads.  A Bear Put Spread position is always considered a debit spread because the purchase of the in-the-money (higher) put strike price costs more than is received for selling the out-of-the-money (lower) put option.

Bear Put Spread Example

Let's go through a bear put spread example from the CallsAndPuts.com "Bear Put Spread" data:

Stock Company Name/Ticker Symbol:                      Oracle Corporation (ORCL)
Stock Price:                                                                $67
Sold Out-Of-The-Money Put Option (Short Position):       1 contract - June $65 @ $3.75
Bought In-The-Money Put Option (Long Position):           1 contract - June $70 @ $6.63
Call Options Expiration Date:                                        June (The market close of the third Friday of the month)

This position is considered a net debit of $2.88, spread of $5.  That is the difference between the sale of the out-of-the-money (lower) put option and the purchase of  the in-the-money (higher) put option which results in a negative cash flow (debit) of $2.88 ($6.63 - $3.75).  The spread represents the difference between the in-the-money and out-of-the-money strike prices, which are $5 apart (June $70 put option - June $65 put option).  So, what does all of this translate to for potential profit?  Let's assume the stock price is below the out-of-the-money (lower) put option strike price ($65) on the June expiration date.  That would translate to a maximum profit of the difference between the strike prices minus the net debit or $5 - $2.88 = $2.12 x 1 contract (100 shares) for a maximum profit of $212 per contract.

Now let's look at the maximum loss potential should the stock price go above the higher option strike price on the June expiration date.  Due to our Bear Put Spread option positions, we have pre-determined the maximum amount we are willing to lose.  That maximum loss potential translates to the $2.88 debit spread x 1 contract (100 shares) = $288 per contract.  

To summarize:

Net Debit = Money received from selling out-of-the-money (OTM) put options - Money paid for buying in-the-money (ITM) put options

Maximum Profit Potential = Difference Between Strike Prices - Net Debit

Maximum Loss Potential = Net Debit

Example - Using the CallsAndPuts.com "Bear Put Spread" Data

Now that we've explained the Bear Put Spread strategy, let's use the CallsAndPuts.com "Bear Put Spread" data to select an option play for an additional example: Bear Put Spread Example

CoveredCalls.com

Site Resources: