A Bear Put Spread involves buying a put option and selling a put options with a lower strike within the same expiration month.
• Cost Basis Reduction: Bearish Put Spreads too allow Cost Basis Reduction.
• Moderate Downward Movement: It is also executed when the general feeling towards an asset is negative and a moderate downward movement is expected.
• Low Risk, Low Reward and Lower Requirements: Debit Put Spread also involves low Risk, has low Requirements and will provide low Reward. This allows you to participate in more expensive Stocks.
• Exchanging Upside Potential for Chance to Recover Premium: There will also be a higher Probability of Success compared to Long Puts. This makes sense as you are selling OTM put, thus reducing the Capital Requirements and cost basis, and increasing the Probability of Success.
• Sell OTM Put Option with a lower Strike Price.
• Buy ITM Put Option with a higher Strike Price.
• Use the same underlying asset and the same contract Expiration Date based on Analytics accuracy.
• Select Strike Prices based on Probability of Success, and Tradespoon’s analytics.
In Figure 16, the x-axis denotes the Stock Price and y-axis denotes the Profit/Loss. Point B denotes the buying price and Point A denotes the selling price, which are the Strike Price selections. The Expiration Month is again 50-75 days. So, Maximum Gain will occur at Point A and Maximum Loss will occur at Point B. The Break Even Point is between Point A and B and depends on how much Debit you paid. This is a directional trade with a bearish bias.
Return on Capital
• With Bear Put Spreads, you pay the cost of the Long Put (at-the-money option) and you earn proceeds from the sale of Short Put Option (out-of-the-money option).
• Capital Required is the original Debit paid for the Spread.
• Maximum Gain is the difference between the two Strike Prices minus the original Debit paid.
• Maximum Loss is the original Debit paid.
• Breakeven Point again depends on how much premium you paid for the Spread, and will be somewhere between the Strike Prices where the blue line intercepts the x-axis.