A bull 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 higher strike price (i.e. farther in the money). The profit comes from the difference in the strike prices of the two puts. If the price moves up a small amount, the long put will expire worthless, but the short put will expire in profit, and if the price moves up by a large amount, both puts will expire worthless. If the price moves down, both puts will go into profit. The trade is entered at a credit (the long put costs less than the premium received for the short put), and is therefore a credit spread strategy (i.e. the maximum profit is received upon entering the trade).
Making a Bull Put Spread
- Purchase a single at the money put contract
- Sell a single in the money put contract
- Wait for the price to move above the short put strike price
- Let both puts expire worthless.
Risk and Reward
As shown on the risk / reward chart (view the full size chart), the risk of a bull put spread is low, and is limited to the difference between the strike prices of the long and short puts, minus the initial credit made when entering the trade (the premium received for the short put minus the cost of the long put) regardless of how far the price moves down (against the trade). The risk of a bull put spread is calculated as :
Maximum Risk = Different between long and short put strike prices - Initial credit
Loss = Short put strike price - Long put strike price - Initial credit
The reward of a bull put spread is limited to the initial credit made when entering the trade. The profit of a bull put spread is calculated as :
Maximum Profit = Initial credit
Profit = Short put premium - Long put premium
