Bull Put Spread
Risk: low
Reward: low
General Description
Entering a bull put spread position typically entails selling in-the-money puts and buying out-of-the-money puts.
The Thinking
This strategy is employed when you are bullish and like the idea of selling puts (rather than buying calls) but would also like a little downside protection just in case the underlying issue drops.
Example
Let's say KO is trading @ 54.14 and you think it will rally. You like the idea of selling puts rather than buying calls so you sell the 55 puts for $2.55. This is the naked put strategy , but you want a little downside protection just in case the stock declines. You then buy the 50 puts for $0.85.
Your max profit is locked in place at the onset and occurs above 55. That's where all puts will expire worthless and your profit is the premium collected from your short put position minus the cost of the long puts. You max loss occurs at 50. This is where the long put position will expire worthless and the short put position will be worth $5. You will then either have to buy back your short puts at a greater price than what you paid, or the stock will be “put” to you (i.e. you will be forced to buy it) at $55.0. Below 55, your long and short positions cancel each other out.
The image below summarizes the trade with a P/L Diagram. |
