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 stoc k 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
positio n.
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.
Strategy : BUY A PUT with a higher strike (ITM) +
SELL A PUT with a lower strike (OTM)
|
Nifty index
|
Current Value
|
2694
|
|
|
|
|
|
Buy ITM Put Option
|
Strike Price (Rs.)
|
2800
|
|
|
|
|
|
Mr. XYZ pays
|
Premium (Rs.)
|
132
|
|
|
|
|
|
Sell OTM Put Option
|
Strike Price (Rs.)
|
2600
|
|
|
|
|
|
Mr. XYZ receives
|
Premium (Rs.)
|
52
|
|
|
|
|
|
|
Net Premium Paid
|
80
|
|
|
(Rs.)
|
|
|
|
Break Even Point
|
2720
|
|
|
(Rs.)
|
|
The
payoff schedule|
On expiry Nifty
|
Net Payoff from
|
Net Payoff from
|
Net payoff
|
|
closes at
|
Put Buy (Rs.)
|
Put Sold (Rs.)
|
(Rs.)
|
|
2200
|
468
|
-348
|
120
|
|
2300
|
368
|
-248
|
120
|
|
2400
|
268
|
-148
|
120
|
|
2500
|
168
|
-48
|
120
|
|
2600
|
68
|
52
|
120
|
|
2720
|
-52
|
52
|
0
|
|
2700
|
-32
|
52
|
20
|
|
2800
|
-132
|
52
|
-80
|
|
2900
|
-132
|
52
|
-80
|
|
3000
|
-132
|
52
|
-80
|
|
3100
|
-132
|
52
|
-80
|
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.
The
payoff chart (Bear Put Spread)
+ =
Sell lower strike Put Buy Put Bear Put Spread
