Simplest Meaning Would be “In order to maximize profits while limiting losses, the bearish investor uses an options technique known as a “bear put spread”.
When a bear put spread strategy is used, it includes both purchasing and selling puts for the same asset class, but at separate strike prices, at the same expiration date.
In other words – A bear put spread involves purchasing one put option and selling another put option with a lower strike price. This is done to reduce the overall cost of the trade by offsetting some of the upfront cost.
- One other notable feature of Bear Put Spread Options Strategy is the fact that they generally include some type of funding, in which the purchase of one option is backed by the sale of another option. This is an example of a “buy-write” spread.
- To put it another way, funding is one of the fundamental differences between the spread and a conventional, straight-forward position.
- In this blog, we will talk about techniques that you can use when your view varies from moderately negative to outright bearish. These tactics can be used at any point in time.
- These strategies are composed in a similar way to the bullish strategies we studied earlier also in one of our blogs. (Kindly refer Street of Finance site for some of the more interesting blogs like this)
The term “Bear Put Spread” can also refer to the “Debit Put Spread” or the “Long Put Spread”.
When To use Bear Put Spread Options Strategy?
This method is utilized when the trader has a relatively negative outlook on the direction of prices of the underlying asset but want to minimize the initial cost of his “long Put position” by obtaining a premium on his short Put position.
If the stock price falls toward the lower strike price, the bear put spread functions similarly to its long put component as a stand-alone strategy. On the other hand, in contrast to a simple long put, there is no longer any chance of larger profits after that point. In other words, while the short put premium lowers the overall strategy’s expense, it also lowers the potential reward.
| Parameter | Formula | Level of Loss/Gain |
| Maximum profit | (Strike price of ITM Put – Strike price of OTM Put) – (Premium of ITM Put – Premium of OTM Put) | Limited |
| Maximum Loss | Premium of ITM Put – Premium of OTM Put | Limited |
| Breakeven | Strike price of long ITM Put – (Premium of ITM Put – Premium of OTM Put) | – |
- Gains (returns) that are equivalent to the difference between the strike price and the net premium paid at the commencement of trade will be realized when the options are exercised, which will result in the maximum profit possible.
- If the options (Bear Put Spread) were not exercised, the maximum loss possible would be incurred, which would be equal to the amount of the net premium that was paid at the commencement of the deal.
Suppose, Nifty is currently trading at 7438, which means that the 7460 PE is profitable and the 7266 PE is losing money. For one to engage in the “Bear Put Spread,” they would first need to sell 7266 PE. The premium accrued from the sale would then be used to partially finance the acquisition of 7460 PE.
The 7460 PE premium paid is Rs.145 and the 7400 PE premium received is Rs.64/-. This transaction would result in a net debit of – The range from 64 to 145 (64-145) = (-81)
| Consider a variety of expiration possibilities to see how the strategy’s reward changes. Payoff is upon expiration, thus the trader must maintain these positions until then. | |
| Possibility 1 | Market expires at 7660 (above long put option i.e7460) |
| Possibility 2 | Market expired at 7460 (at long put option) |
| Possibility 3 | Market expires at 7579 (breakeven) |
| Possibility 4 | Market expires at 7266 (at short put option) |
| Possibility 5 | Market expires at 7145 (below the short put option) |
Note: This is just a graphical representation of a bull call spread, to help you understand how its graph looks. It’s only a supposition. You should not rely on them.
| Market Expiry | Long Put_IV | Premium Paid | Long put payoff | Short put_IV | Premium Received | Short put payoff | Strategy Payoff |
| 6460 | 1000 | -145 | 855 | 806 | 64 | -742 | 113 |
| 6560 | 900 | -145 | 755 | 706 | 64 | -642 | 113 |
| 6660 | 800 | -145 | 655 | 606 | 64 | -542 | 113 |
| 6760 | 700 | -145 | 555 | 506 | 64 | -442 | 113 |
| 6860 | 600 | -145 | 455 | 406 | 64 | -342 | 113 |
| 6960 | 500 | -145 | 355 | 306 | 64 | -242 | 113 |
| 7060 | 400 | -145 | 255 | 206 | 64 | -142 | 113 |
| 7160 | 300 | -145 | 155 | 106 | 64 | -42 | 113 |
| 7260 | 200 | -145 | 55 | 6 | 64 | 58 | 113 |
| 7360 | 100 | -145 | -45 | 0 | 64 | 64 | 19 |
| 7460 | 0 | -145 | -145 | 0 | 64 | 64 | -81 |
| 7560 | 0 | -145 | -145 | 0 | 64 | 64 | -81 |
| 7660 | 0 | -145 | -145 | 0 | 64 | 64 | -81 |
| 7760 | 0 | -145 | -145 | 0 | 64 | 64 | -81 |
| 7860 | 0 | -145 | -145 | 0 | 64 | 64 | -81 |
| 7960 | 0 | -145 | -145 | 0 | 64 | 64 | -81 |
Summary
As long as the trader believes that the stock will fall within a predetermined price range, a bear put spread can be a viable option. This trade’s overall cost can be reduced by selling a put option.
The risk of a bear put spread is lower than the risk of buying a put contract on its own. The greatest potential profit is similarly limited; hence, the gain from the long put is countered by the loss from the short put if there is a significant decline in the stock price.
As soon as the stock price reaches the objective, we may close out the position and limit both our profit and loss before the contract expires. This is possible since both profit and loss are limited.
(Caution: Streetofinvestment.com does not make any recommendations on which stocks, portfolios, transactions or investing strategies are appropriate for any specific individual. Not one piece of expert advice is being given by the author or site holder. To decide whether or if any of the tactics suggested in this article are appropriate for the reader’s specific situation, the reader should confer with an experienced financial advisor. This page was created to assist users in gathering the necessary knowledge from a variety of sources that are recognized as being authoritative in their respective subject areas. No warranties or guarantees are offered, and any trademarks, if any, belong solely to their respective owners.)