Bear Put Spread
Risk: low
Reward: low
General Description
Entering a bear put spread typically entails buying in-the-money puts and selling out-of-the-money puts.
The Thinking
This strategy is employed when you are bearish but don't think the stock will crash. Essentially you are buying puts as you normally would in a long put play, but since you don't think the stock will crash, you sell out-of-the-money puts for a little extra cash.
Example
Let's say MO is trading at @ 56.89, and you buy the 60 puts for 3.5 (because you think the stock will move down) and then sell the 50 puts for 0.50 (because you don't think the stock will fall below this level). If the stock falls as you expect, you will make money on the 60 puts, and as long as the stock stays above 50, you keep the entire premium for selling the 50 puts. Your max profit occurs at 50 and below; this is where the long and short positions cancel each other out. Your max loss occurs above 60 – all puts will expire worthless and your loss will be the initial capital necessary to enter the position.
The image below summarizes the trade with a P/L Diagram. |
