What Is A Bear Put Spread Options Trading Strategy?
A Bear Put Spread strategy involves two put options with different strike prices but the same expiration date. Bear Put Spread is also considered as a cheaper alternative to long put because it involves selling of the put option to offset some of the cost of buying puts.
When To Initiate A Bear Put Spread Options Trading?
A Bear Put Spread strategy is used when the option trader thinks that the underlying assets will fall moderately in the near term. This strategy is basically used to reduce the upfront costs of premium, so that less investment of premium is required and it can also reduce the affect of time decay. Even beginners can apply this strategy when they expect security to fall moderately in near the term.
How To Construct The Bear Put Spread?
Buy 1 ITM/ATM Put
Sell 1 OTM Put
Bear Put Spread is implemented by buying In-the-Money or At-the-Money put option and simultaneously selling Out-The-Money put option of the same underlying security with the same expiry.
|Strategy||Buy 1 ITM/ATM put and Sell 1 OTM put|
|Market Outlook||Moderately Bearish|
|Breakeven at expiry||Strike price of buy put - Net Premium Paid|
|Risk||Limited to Net premium paid|
Let’s try to understand Bear Put Spread Options Trading with an example:
|Nifty current market price||Rs. 8100|
|Buy ATM Put (Strike Price)||Rs 8100|
|Premium Paid (per share)||Rs 60|
|Sell OTM Put (Strike Price)||Rs 7900|
|Premium Received||Rs 20|
|Net Premium Paid||Rs 40|
|Break Even Point (BEP)||Rs 8060|
|Lot Size (in units)||75|
Suppose Nifty is trading at Rs 8100. If you believe that price will fall to Rs 7900 on or before the expiry, then you can buy At-the-Money put option contract with a strike price of Rs 8100, which is trading at Rs 60 and simultaneously sell Out-the-Money put option contract with a strike price of Rs 7900, which is trading at Rs 20. In this case, the contract covers 75 shares. So, you paid Rs 60 per share to purchase single put and simultaneously received Rs 20 by selling Rs 7900 put option. So, the overall net premium paid by you would be Rs 40.
So, as expected, if Nifty falls to Rs 7900 on or before option expiration date, then you can square off your position in the open market for Rs 160 by exiting from both legs of the trade. As each option contract covers 75 shares, the total amount you will receive is Rs 15,000 (200*75). Since, you had paid Rs 3,000 (40*75) to purchase the put option, your net profit for the entire trade is, therefore Rs 12,000 (15000-3000). For the ease of understanding, we did not take in to account commission charges.
Following is the payoff schedule assuming different scenarios of expiry.
The Payoff Schedule:
|On Expiry NIFTY closes at||Net Payoff from Put Buy (Rs)||Net Payoff from Put Sold (Rs)||Net Payoff (Rs)|
Bear Put Spread’s Payoff Chart:
The overall Delta of the bear put position will be negative, which indicates premiums will go up if the markets go down. The Gamma of the overall position would be positive. It is a long Vega strategy, which means if implied volatility increases; it will have a positive impact on the return, because of the high Vega of At-the-Money options. Theta of the position would be negative.
Analysis of Bear Put Spread strategy:
A Bear Put Spread strategy is best to use when an investor is moderately bearish because he or she will make the maximum profit only when the stock price falls to the lower (sold) strike. Also, your losses are limited if price increases unexpectedly higher.
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