Bear Put Spread
Bear Put Spread Overview
The bear put spread options trading strategy is utilized when a trader wishes to bet on the downside in the market with limited risk. The bear put spread is a low risk, moderately high reward strategy which involves buying an in the money put option and shorting an out of the money put option at the same time. Both options will have different strike prices but the same expiration date.
Bear Put Spread Risk Characteristics
As depicted below, the risk associated with this trade is merely the net debit paid to initiate the spread. As you can see in the diagram below, the maximum loss in this trade occurs at the strike price of the ITM Put. Remember, if the stock closes above the upper strike price, the puts are worthless and therefore the monies paid to put this trade on are lost.
Maximum Risk of Bear Put Spread: Long Put Cost - Short Put Cost
We mentioned above that this strategy has moderate profit potential. We used the term "moderate" because we are going long one option and short another. The short put in this spread will limit the profit potential as the stock moves lower in exchange for a credit which reduces the cost to put the position on.
Therefore, we can calculate the profit potential of the bear put spread with the following formula:
Maximum Profit Potential: Strike Price of Long Put - Strike Price of Short Put - Net Debit
Being a net debit transaction, the stock will need to move in the anticipated direction by an amount equal to what you paid to put the bear put spread on.
Breakeven: Strike Price of Long Put - Net Debit