Following up on the option strategies posts, today I'll explain what is a Bear Put Spread. This strategy is a negative net Delta position; which means it profits when the underlying goes down... very handy these days! You want to enter this position at a top when the market is overbought or at a resistance level when you have a strong negative bias. If you haven't already, read my previous post on the Bull call spread because it covers some basic concepts that I will skip in this post.
The bear put spread is built using 2 put options at the same expiration date:
- Long 1 put for the chosen strike price, usually at the money (ATM)
- Short 1 put for a lower strike price, usually out of the money (OTM)
Risk
As with the Bull Call Spread, the maximum risk for the strategy is the amount paid for the spread. There are no margin requirements. The maximum profit you can get from a bear put spread is limited to the difference between the strikes minus the amount paid for the spread.
Entry rules
- Bearish outlook for the underlying stock
- Buy options with at least 30 trading days left before expiration
- Aim for a 2:1 to 3:1 gain/risk ratio: about $1.25 to $1.65 for a $5 spread
Exit rules
- Close position at least 20 trading days prior to expiration
- Close position if value drops below 60% of initial purchase price
- Close half the position when 100% profit achieved; Close the remaining half when the spread is valued at 80% of the total value of the spread ($4 for a $5 spread)
Strategy graph
The performance graph for this position when bought:
Performance graph at expiration:
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