Vertical Put Spread

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Also Know As Short Put Spread or Bull Put Spread

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Directional Assumption

Bullish

A short put spread obligates me to buy the stock at short put strike price if it is assigned but gives me the right to sell stock at the long put strike price A.

A Vertical Put Spread is an alternative to the short put. In addition to selling a put, I am buying the cheaper to limit my risk if the stock goes down. But there’s a tradeoff — buying the put also reduces the net credit received when running this strategy.

When to Run It

I am anticipating that the price of the underlying stock goes up.

If the price of the stock goes down and past the breakeven point, I may be assigned the short put and will owe a defined loss.

Setup

  • Sell OTM Put (closer to ATM)
  • Buy OTM Put (further away from ATM)

NOTE: Both options have the same expiration month.

Timeline

30-45 days

Ideal Implied Volatility

** 50% or greater**

Short puts allow me to capitalize when anticipating a decrease in
implied volatility (IV).

Profit Target

Winner : If my position shows a profit near 50% of the max potential gain, I will close the position early to lock in profits.

Time Decay

As time goes by theta works in my favor as I collect premium as long as the price stays above the short put strike price.

Maximum Profit

Potential profit is limited to the net credit received.

Maximum Loss

This is a defined risk trade.

The Breakeven is the Strike price minus the net credit received.

The max loss is the price limited to the difference between the short put strike and the long put strike, minus the net credit received.

Risk Management

This trade should be 1% or less of my account.

Tip

One advantage of this strategy is that I want both options to expire worthless. If that happens, I won’t have to pay any commissions to get out of my position and I keep the credit.

I may wish to consider that strike B is around one standard deviation out-of-the-money at initiation. That will increase my probability of success. However, the further out-of-the-money the strike price is, the lower the net credit received will be from this spread.


Categories: Strategies