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Bear Put Spread - An Option Trading Strategy

Today, we shall see the details of the bear put spread option strategy used in the options market. The bear put spread has multiple legs. In this strategy, the risk of the position is defined. The strategy can be very profitable when the price of the underlying asset falls before the contract expires.


The bear put spreads are the debit spreads strategy in which the option traders buy the put option contract and sell the put options contract at a low price. High volatility in the underlying stock can benefit the bear put spread.


Generally, traders use this strategy when they believe that the underlying asset's price will decrease on or before the expiry of the contract. This strategy is also commonly known as put debit spreads as they require paying a debit upon entering the strategy. As we said, this strategy has limited risk, and that is limited to the debit paid at the initial stage. The highest profit of this strategy is the spread's width minus the premium paid initially.


If the strike price is closer to the underlying stock's price, the trader has to pay more debt, but also, the chances of an option expiring in the money will increase.


How to enter the bear-put option strategy?

To enter the bear put option strategy, traders select buy-to-open a put option contract and sell-to-open a put option contract at a lower strike price. Both contracts have the same underlying asset and the same expiry date. The above order will result in paying a debit, and selling lower put options will help reduce the overall cost of the trade.


Example

A trader buys a put option contract at ₹50 and sell a put option contract at ₹45, and the cost incurred is ₹1. In this case, if the stock closes at a price above ₹50, then the trader will have a loss of -₹100. If the stock closes below ₹45 at the time of expiry, then the trader will have a profit of ₹400. And the breakeven point will be ₹49

  • Buy-to-open - ₹50 Put option contract

  • Sell-to-open - ₹45 Put option contract

Understanding the diagram of bear put spread:

The risk and rewards are clearly visible in the below diagram. The debit amount or premium amount is paid initially upon entering the strategy. The max loss on the strategy is the initial premium paid. The maximum profit a trader makes is the spread's width minus the debit paid initially.

Bear Put Spread - An Option Trading Strategy

How to exit a put debit spread?

  • To exit the strategy trader can reverse the order by sell-to-close (STC), the long put option, and buy-to-open (BTC), the short put option contract.

  • If the traders sell the spread more than the purchase price, they will realize the profit.

  • If the stock closes at a price below the short put option at the time of expiry, then the contracts will be offset, and the position will realize a profit.

Additional notes on the strategy:

  • The time decay factor or theta factor works against the strategy.

  • Bear put spread strategy earns profit if the implied volatility increases.

  • In adverse market situations, the bull call spread can be added to the existing strategy, and it will create a reverse iron butterfly.

  • To extend the duration of the trade, the position can be rolled, and to do that, the trader has to sell the existing spread and purchase a new spread at a new expiry time.

Conclusion:

So, we have seen how traders can benefit even if the price is declining in the market, and by utilizing this strategy at the correct time, traders can limit their losses and profit. In case you have any questions, get them solved by reaching us at 8447445815 / 9909978783

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