The Bull Put Spread

The Bull Put Spread is very similar to the bull call spread, but is constructed using Put options rather than Call options.

When should I use it?

When you have a moderately bullish view on a stock.

Why use it?

It is a cheaper way of gaining exposure to a rise in the stock price than an outright buy of a call option and is safer than a naked written put.

Construction:

Below is an example. The strategy simultaneously Sells a Put Option and Buys a Put Option at a lower strike price ($38.50P, $37.00P).

• Max Loss is the difference between the strike prices less the Net premium received ($38.50-37.00-0.80 = $0.70).
• Max Profit is the net premium received ($1.03-$.23 = $0.80).
• Breakeven is when the higher strike less net premium received on the spread ($38.50 - $.80 = $37.70.

Time decay can vary depending on the strike prices chosen, the idea being that the time value effects on the bought leg will offset by the written leg (neutral on the trade).

Volatility = generally neutral, but depends on the strike prices chosen (neutral on the trade).

Margins = Yes, varies daily, but it is limited to a maximum equal to the maximum loss on the strategy. ($38.50-37.00-0.80 = $0.70)

Bull Put Spread Example

Entry: Bull Put Spread on Commonwealth Bank (CBA) on 30/06/05 when CBA was trading at $37.68

• Sold CBA Jul $38.50 Put @ $1.03
• Bought CBA Jul $37.00 Put @ $0.23
• Net Credit $0.80

The prices were:

• CBA July $38.50 Put $1.03
• CBA July $37.00 Put $0.23

Exit: Take profits on 14/07/05 (when CBA was trading $38.50) Prices that could be attained were:

• Bought back CBA Jul $38.50 Put @ $0.28
• Sold CBA Jul $37.00 Put @ $0.02
• Net Debit $0.26

This delivered a gain of $0.54 per contract ($0.80 received per contract when opening the spread minus the $0.26 we paid out to close the spread), with a maximum initial margin requirement of $0.70.

The strategy returned a profit of 77.1% over two weeks.