A put spread involves the simultaneous buying and selling of options of the same type, puts or calls, and expiry at different strike prices. Investors will use a vertical spread when they expect a moderate move in the stock or index price. Depending on the type of spread deployed, the investor's account will either be credited or debited.
Seeking Alpha concludes, "Historically when the market starts to decline it causes volatility to spike higher, making put options spike in price as well because volatility is a major component in pricing options. Therefore it is important to purchase put protection in times of complacency and when volatility is cheap (or when we don't really need it)."
This hedge requires a combination of option calls and puts and therefore is only suitable for savvy investors.
Good to Fair
This strategy only protects from moderate moves in the stock or index price. Not large price swings.
Low to Moderate
Depending on the type of vertical spread deployed, the invetors account will either be credited or debited.
A comparison between bull and bear put spreads:
|Spread||Max Profit||Max Loss||Breakeven Point|
|Bull Put Spread||net premium received||the spread between the strike prices - net premium received||short put strike price - net premium receive|
|Bear Put Spread||the spread between the strike prices - net premium paid||net premium paid||long put strike price - net premium paid|
An investor purchases XYZ stock for $30 per share. To protect against potential loss, they purchase a bear put spread as follows:
|1. Purchase Put Option||$35||$475 ($4.75 x 100 shares/contract)|
|2. Sell Put Option||$30||$175 ($1.75 x 100 shares/contract)|
The total cost for the hedge is $300 from the purchase price of $475, minus the premium from the selling price of $175. If the underlying stock closes below $30 by expiration, the investor will realize a total profit of $200.
© 2020 Todd Moses
The strategies discussed are for illustrative and educational purposes and are not a recommendation, offer, or solicitation to buy or sell any currency or to adopt any investment strategy. There is no guarantee that any strategies discussed will be useful. Todd Moses is not a licensed securities dealer, broker, or US investment adviser or investment bank.