A bear put spread is an independant trade, that uses a combination of two puts, but is still a single direction strategy. The trader buys a single put contract at any strike price, and then sells a single put contract at a lower strike price (i.e. farther out of the money). The profit comes from the difference in the strike prices of the two puts. If the price moves up, the puts will expire worthless, and if the price moves down, both puts will go into profit. The trade is entered at a debit (the long put costs more than the premium received for the short put), and is therefore a debit spread strategy (i.e. the maximum loss is taken upon entering the trade).
Making a Bear Put Spread
- Purchase a single in the money put contract
- Sell a single out of the money put contract
- Wait for the price to move below the short put strike price
- Exercise both puts to realize the profit.
Risk and Reward
As shown on the risk / reward chart (view the full size chart), the risk of a bear put spread is low, and is limited to the difference between the premiums of the long and short puts (the debit taken when entering the trade) regardless of how far the price moves up (against the trade). The risk of a bear put spread is calculated as :
Maximum Risk = Difference between long and short put premiums
Loss = Long put premium - Short put premium (the initial debit)
The reward of a bear put spread is limited to the difference between the strike prices of the long and short puts minus the initial debit taken when entering the trade. The profit of a bear put spread is calculated as :
Maximum Profit = Difference between long and short put strike prices
Profit = Long put strike price - Short put strike price - Premium paid for both puts (initial debit)
