Advanced Strategies for Options - Bull Put Spread

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Advanced Strategies for Options - Bull Put Spread

The bull spread with puts is very similar to the bull spread using calls in that the investor still buys one option and sells another option with a higher strike price for the same underlying security. The difference is the investors uses puts rather than calls. Let's return to our example.

George is still modestly bullish for Dupont. With the common stock trading at $85 he places the following order. He buys 1 contract of the Dupont December 85 put at a cost of $1.50 per contract and simultaneously sells one Dupont December 90 put for net proceeds of $5.50 per contract. This transaction creates a net credit of $4.00 per contract or $400. Now let's run through the results of this spread at option expiration.

Dupont Share Price at Expiration	Profit for December 85 puts	Profit for December 90 puts	Total Profit
75	$850	($950)	($100)
80	$350	($450)	($100)
85	($150)	$50	($100)
86	($150)	$150	0
90	($150)	$550	$400
95	($150)	$550	$400
100	($150)	$550	$400

As we can see, George's' strategy using puts works very well unless the common stock falls to $85 or lower, the lower strike price in this spread. We can also see that George breaks even if the common stock ends at $86, the differences between the two strike prices in the spread less the credit received. Finally, George gets his maximum profit if the stock rises to $90, the higher strike price.

For the sake of simplicity we have used conservative bull spread strategies but the bull spread can be modified to make it very conservative or extremely aggressive.

Conservative bull spreads are those where both the long and short positions are in- the- money. This strategy is deemed conservative because the odds are greatest that the position will achieve its maxim profit potential with the least amount of risk (remember, the maxim profit potential is achieved when the underlying common stock reaches or exceeds the strike price of the short contract). Because both the long and short options are in- the- money, profit potential will be small for this position.

A more aggressive bull spread strategy involves positioning the spread around the underlying common stock price. For example, an aggressive bull spread using calls would see the investor go long the at-the-money call option and sell a call option well out-of-the money. Because the maxim profit is achieved when the common stock reaches the higher strike price this strategy offers greater reward but risk is also higher.

The most aggressive bull spread strategy involves spreading two out-of-the-money calls. In this strategy the cost of the spread is very small and a large move in the stock price will produce a huge return but the odds of large moves are often remote. If the stock advances modestly, or worse, not at all the entire investment may be loss.

Bull Spread Review

Bulls spreads may be implemented using either puts or calls and it is considered to be a strategy best used if the investor is moderately bullish for the underlying common stock. The strategy offers both limited risk and limited reward. Risk and reward is determined by the strike prices selected. Generally, out-of-the-money bull spreads offer greater reward but much more risk.

For Bull Spreads Using Puts

1. The transaction creates a credit because the short put option with a higher strike price will always be more expensive than the long put option with a lower price.

2. The maximum loss is limited to the difference between the two strike prices less the net credit received.

3. The break-even point for the spread is the higher strike price less the net credit.

4. The maximum profit is limited to the net credit received.

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