BULL PUT SPREAD STRATEGY: SELL PUT OPTION, BUY
PUT OPTION
A bull put spread can be profitable when the
stock / index is either range bound or rising. The concept is to protect the
downside of a Put sold by buying a lower strike Put, which acts as an insurance
for the Put sold. The lower strike Put purchased is further OTM than the
higher strike Put sold ensuring that the investor receives a net credit,
because the Put purchased (further OTM) is cheaper than the Put sold. This strategy
is equivalent to the Bull Call Spread but is done to earn a net credit
(premium) and collect an income.
If the stock / index rises, both Puts expire
worthless and the investor can retain the Premium. If the stock / index falls,
then the investor’s breakeven is the higher strike less the net credit
received. Provided the stock remains above that level, the investor makes a
profit. Otherwise he could make a loss. The maximum loss is the difference in
strikes less the net credit received. This strategy should be adopted when the
stock / index trend is upward or range bound. Let us understand this with an
example.
When to Use: When the
investor is moderately bullish.
Risk: Limited.
Maximum loss occurs where the underlying falls to the level of the lower
strike or below
Reward: Limited
to the net premium credit. Maximum profit occurs where underlying rises
to the level of the higher strike or above.
Breakeven: Strike Price of
Short
Put - Net
Premium
Received
Example:
Mr. XYZ sells a Nifty Put option with a strike
price of Rs. 4000 at a premium of Rs. 21.45 and buys a further OTM Nifty Put
option with a strike price Rs. 3800 at a premium of Rs. 3.00 when the current
Nifty is at 4191.10, with both options expiring
on 31st July.
Strategy
: Sell a Put + Buy a Put
|
Nifty Index
|
Current Value
|
4191.10
|
|
|
|
|
|
Sell Put Option
|
Strike Price (Rs.)
|
4000
|
|
|
|
|
|
Mr. XYZ Receives
|
Premium (Rs.)
|
21.45
|
|
|
|
|
|
Buy Put Option
|
Strike Price (Rs.)
|
3800
|
|
|
|
|
|
Mr. XYZ Pays
|
Premium (Rs.)
|
3.00
|
|
|
|
|
|
|
Net Premium
|
18.45
|
|
|
Received (Rs.)
|
|
|
|
|
|
|
|
Break Even Point
|
3981.55
|
|
|
(Rs.)
|
|
The
payoff schedule|
On expiry Nifty
|
Net Payoff from Put
|
Net Payoff from
|
Net Payoff
|
|
Closes at
|
Buy (Rs.)
|
Put Sold (Rs.)
|
(Rs.)
|
|
3500.00
|
297.00
|
-478.55
|
-181.55
|
|
3600.00
|
197.00
|
-378.55
|
-181.55
|
|
3700.00
|
97.00
|
-278.55
|
|
|
3800.00
|
-3.00
|
-178.55
|
-181.55
|
|
3900.00
|
-3.00
|
-78.55
|
-81.55
|
|
3981.55
|
-3.00
|
3.00
|
0.00
|
|
4000.00
|
-3.00
|
21.45
|
18.45
|
|
4100.00
|
-3.00
|
21.45
|
18.45
|
|
4200.00
|
-3.00
|
21.45
|
18.45
|
|
4300.00
|
-3.00
|
21.45
|
18.45
|
|
4400.00
|
-3.00
|
21.45
|
18.45
|
|
4500.00
|
-3.00
|
21.45
|
18.45
|
|
4600.00
|
-3.00
|
21.45
|
18.45
|
|
4700.00
|
-3.00
|
21.45
|
18.45
|
|
4800.00
|
-3.00
|
21.45
|
18.45
|
