🔍
How to Trade Bull Put Spreads (aka Short Put Verticals) | Official thinkorswim® Web Tutorial - YouTube
Channel: TD Ameritrade
[0]
When youíre trading options,
especially if youíre a beginner,
[3]
you may lean toward single options
strategies like long calls or short puts
[7]
because you only have to manage one option.
But these strategies have some drawbacks.
[12]
With long calls you have to correctly predict
short-term stock behavior, which isnít easy. Naked
[18]
puts carry substantial risk, and cash-secured
puts can tie up a lot of cash in your account.
[23]
These drawbacks are why some strategies combine
multiple options contracts. These are called
[28]
spreads, and theyíre popular because they
allow you to define your risk and reward.
[32]
There are many ways to combine options into
spreads based on your goals and risk tolerance.
[37]
Weíre going to focus on one of the most common:
the bull put spread, or as we like to call it,
[42]
the short put vertical. This bullish
strategy is known by several different names,
[46]
such as a credit put spread or short put spread,
but itís a basic concept: You sell one put to
[53]
potentially profit from a stock going up, but
also buy another put at a different strike,
[58]
which provides protection in case it doesnít. This
allows you to define your risk and your reward.
[64]
Iím Education Coach Cameron May, and Iíve been
teaching traders about options for 15 years.
[70]
Combining multiple options together
in one trade can seem complicated, but
[75]
weíre going to walk through all the ins and outs.
Weíll break down how the short put vertical works
[80]
and how to set it up on thinkorswim
Web, our browser-based trading platform.
[84]
Itís got a lot of the powerful options
trading tools of thinkorswim desktop
[88]
but in a simplified interface you can access
just by going to trade.thinkorswim.com.
[95]
Weíll assume you already know the basics
of options trading and the greeks. If
[99]
youíre an absolute beginner, check out our other
videos to get your bearings on options basics.
[105]
So. Short put verticals. This is
a bullish strategy that involves
[109]
simultaneously selling an out-of-the-money
put and buying another put with the same
[114]
expiration thatís further out of the money. The
short put is the driver of the trade. It benefits
[120]
from time decay and when the underlying stock
goes up, while the long put hedges your risk.
[126]
Youíll have to pay the premium for the
long put, but that part of the trade is
[129]
usually cheaper than the short put, so youíll
wind up with a net credit from the get-go.
[134]
Keep in mind, youíll still have to pay transaction
costs. The ideal outcome is for the stock to stay
[140]
above the short put so both options expire out
of the money. That way you keep the premium
[146]
you received when you entered the trade.
If things donít go your way and your short
[150]
put is assigned, you can exercise the
long put to deliver on your obligation
[155]
to sell the underlying stock at the strike price.
Itís also possible the stock could end up between
[160]
the strikes. This can be a tricky situation,
and weíll walk through ways to handle it later.
[166]
But now that youíre familiar with the
basic mechanics of the short put vertical,
[170]
why should you consider this
strategy? Consider risk versus return.
[176]
As long as you play your strikes right, thereís a
relatively high probability of being profitable.
[181]
Letís look at the strategyís risk
profile to see how this works.
[185]
This is the risk profile of a short put. This will
be your main profit driver. In order for it to be
[191]
profitable, the underlying needs to stay above
the break-even point, which is the strike price
[196]
minus the premium. If it drops below the strike
price, you run the risk of getting assigned.
[202]
Compare that to the risk profile of a long put,
your hedge. You can see the risk is defined.
[208]
Put them together and you can see both the max
loss and max gain are capped. This is what I
[214]
mean when I call this a defined risk and reward
strategy. Youíre basically capping your potential
[219]
gains in return for defining your maximum loss.
This strategy can offer a higher probability of
[225]
success than other bullish strategies like long
calls because unlike bullish single options
[231]
Strategies the underlying stock can go up a lot,
it can go up a little, it can go sideways, or it
[237]
can even go down a little, and the trade can still
be profitable. This offers a lot of flexibility,
[243]
letting you manage how much profit youíre willing
to trade for what probability of success you want.
[249]
There is a trade-off that comes with
that higher probability of success:
[252]
You limit your potential profit.
To get a sense of how these really work together,
[257]
letís look at an example. Letís say youíre bullish
on stock XYZ, and itís currently trading at $99.
[264]
You think itís going to hold steady or move
up slightly, so you sell a put 40 days from
[268]
expiration at the 97 strike for $1.50 premium, or
$150 for the contract, and you buy another put on
[276]
the same expiration further out of the money at
the 95 strike for $60 per contract. With these two
[284]
options combined, your net credit for the spread
is $90, (or $150 minus $60), minus transaction costs.
[292]
Letís say youíre right, and the stock does
increase slightly, up to $101 near expiration.
[298]
A bullish move is the best-case scenario here.
Both options would expire out of the money,
[303]
leaving you with your $90 credit, minus
commissions and fees. Weíll talk about how
[307]
to manage a trade like this a little later on.
But what if the flipside happens, and the stock
[312]
moves down instead? Letís say the stock drops and
is trading at $93 at expiration. If that happens,
[319]
your short put is assigned, meaning youíd
have to buy 100 shares of the underlying.
[324]
But you bought that long put for exactly this
possibility. Because you bought the long put
[330]
for a lower strike price, youíll only be
out the distance between the two strikes.
[335]
Letís break that down by the numbers. Your short
put would cost you $9,700 to buy the 100 shares,
[343]
but the 95 long put would let you sell the
shares for $9,500, leaving you with a $200 loss.
[351]
Remember, you sold this spread for a net credit
of $90, so that would offset this a little for a
[357]
total loss of $110 plus transaction costs. No
matter how much the stock drops it could drop
[364]
down to $50 per share or lower that $110
is the most youíll lose on this spread.
[372]
But what happens if the stock winds up
somewhere in between your two strikes?
[376]
Youíll have an in-the-money short
put and an out-of-the-money long put.
[380]
Depending on factors like the stock price and
how you decide to exit the trade, the trade could
[385]
ultimately still be profitable, but it might not
be. Whatís most important is that youíre at risk
[391]
of being assigned stock because of the short put.
If the stock does end up between the strikes,
[396]
youíve got a couple choices. You could let the
trade expire and get assigned 100 shares of stock.
[402]
But because your goal is not to enter a stock
position, youíll probably want to take some
[406]
action, like closing the trade. Consider closing
both the long and short puts. While the short put
[413]
is the one with assignment risk, closing
the long put at the same time can lock in
[417]
any remaining premium in the long put, which
could help offset a loss on the short put.
[423]
Keep in mind, both of these
would incur transaction costs.
[427]
Now that youíre familiar with potential outcomes
of a short put vertical, letís take a quick
[431]
look at what forces impact the value of the
options. These are price, time, and volatility.
[438]
The first force is price and is measured by
delta. Short put verticals are delta positive,
[444]
which means premiums fall as the stock
price goes up. As the option seller,
[449]
you want this to expire worthless. This
greek will give you a sense of how much
[453]
the options contract price may change with
a $1 move in the price of the underlying.
[459]
The next force is time. Theta measures the
impact of time decay on short put verticals.
[466]
Because the driver of this trade is a short
put that you want to expire worthless,
[470]
itís theta positive. Remember, the max
gain for this strategy is the premium
[475]
you collected when you first placed the trade.
The last force is volatility. Vega tells you
[481]
how rising or falling implied volatility could
impact your options trade. Short put verticals
[487]
have negative vega, so, ideally, youíd
like to see volatility hold steady or fall.
[492]
This makes sense because your ideal outcome is for
both options to lose value and expire worthless.
[499]
Now that youíve got the basics,
letís make some paper trades.
[503]
Iíll log in to thinkorswim Web. Here you
can see all the accounts and positions,
[507]
and that Iím in paperMoney, which allows me to
place simulated trades without risking real money.
[513]
Iím going to close this sidebar
to give us some more room.
[515]
Ok, so our first step is to choose an underlying
asset we want to trade. For this strategy,
[521]
we donít need to own the stock, but we do want
to make sure itís following some entry rules.
[525]
Because this is a bullish strategy, consider
highly liquid assets that are already in an
[530]
uptrend. Of course, thereís no guarantee that
the upward trend will continue, but it could
[534]
increase your probability of success. You could
set up a watchlist of stocks to keep an eye on.
[540]
Next, weíve got to determine
when to actually enter the trade.
[544]
Technical analysis can help. A chart pattern like
a bounce off a price floor or a break through a
[549]
price ceiling could be a signal that a stock
is potentially ready to make an upward move.
[555]
For today weíll use Expedia, symbol EXPE, as
an example. Hereís its 6 month daily chart.
[562]
You can see itís in an upward trend. Let me
draw a trendline here to show what I mean.
[567]
You can see there was a recent
price ceiling around 145.
[570]
Iíll draw another trendline here, so we can
see that itís broken through that ceiling.
[576]
So, we know what stock we want to trade, now
weíve got to choose our options contracts.
[581]
To do that Iíll scroll up
and open the option chain.
[586]
Up first is selecting an expiration. For a short
put vertical, the goal is to hold it to expiration
[592]
and stay out of the money. There is a trade-off
at play here: We could choose an expiration thatís
[598]
closer, which would mean faster time decay but
less premium overall. Further out could provide
[604]
more premium but slower time decay. For a good
balance, Iíll aim for an expiration thatís 15
[610]
to 50 days out. So, in this case, weíll go with
the March 19 expiration, expiring in 36 days.
[617]
Next up is choosing the strikes for our short
and long puts. Again, this is a trade-off. One
[623]
way you adjust the trade-off between probability
and profit is how far out of the money you go with
[629]
that strategy. A common mistake is staying too
close to the at-the-money strike in pursuit of
[634]
higher potential profit or going too far
out of the money for higher probability,
[639]
which significantly limits profits. For our
short put, weíll look for a delta between .30
[644]
and .40. Ideally, this strike price is at or below
support levels, which could mean the stock is less
[651]
likely to fall below our strike. We can see the
140 strike has .32 delta and is below support.
[657]
This will give us a good shot at the option
expiring out of the money while still providing
[662]
a decent amount of premium. It also looks like the
difference between the bid price and the ask price
[667]
is less than 10% of the ask price, which suggests
good liquidity. So letís plan to sell that one,
[673]
so Iíll click the bid price. You can see
itís entered at the bottom of the screen.
[677]
Now, we need to choose the strike for our long
put. This strike should be below our short put.
[683]
Thereís another tradeoff here. The width of the
spread determines how much credit weíll receive
[688]
for selling it. But the wider the spread, the
more risk you open yourself up to because your max
[693]
loss is the distance between the strikes. One
common rule is to choose a long put at least
[698]
$2 below the short put. For us, the next available
strike is $5 away, at 135. Itís allowing us some
[705]
breathing room. Iíll click the ask price.
Youíll notice our order now says vertical.
[711]
Letís scroll down and look at it. So, here in
the order editor I can see Iím selling the March
[716]
19 140 and buying the March 19 135. Now youíll
notice the price of our spread is still moving.
[723]
Letís lock our required credit to a limit of
165. And weíll leave the time in force at day.
[729]
Now we can figure out how many spreads to
trade. To do this, you need to know two things:
[733]
your portfolio risk and your trade risk. Portfolio
risk is the total amount of your portfolio youíre
[739]
willing to lose on a given trade. Consider
setting aside no more than 1% of your active
[744]
trading portfolio per trade. So, for simplicity,
letís say Iím trading with a $100,000 portfolio.
[750]
If Iím willing to lose no more than 1%, my
portfolio risk would be $1,000 per trade.
[756]
Trade risk on the other hand is the
amount you could lose in a given trade.
[761]
For a short put vertical, the trade risk
is the distance between the two strikes
[765]
(think short strike minus long strike) minus
the credit you received from the spread.
[770]
In other words, the spread width minus the credit.
For this trade thatís a $5 wide spread, or $500
[777]
minus the anticipated credit of 1.65,
or $165, for a trade risk of $335
[785]
Now that we know our portfolio and trade risk,
we can figure out how many spreads to sell.
[790]
To do this, take your portfolio risk
and divide it by your trade risk.
[794]
So, our portfolio risk of a 1,000 divided by the
trade risk of $335 equals just about 3 spreads,
[801]
which Iíll enter in the trade ticket.
Now that weíve got our trade loaded up,
[805]
letís do some quick analysis using
a nifty feature on thinkorswim web.
[810]
Below the order ticket youíll see a
stock chart and a risk profile chart.
[815]
On the stock chart you can see two tabs
representing my strikes, and where they
[819]
fall in relation to the stockís historical price.
You can also hover your mouse over either chart to
[824]
get a sense of where a given underlying price
would fall on the other. In the risk profile,
[830]
the curved dotted line represents how different
prices would impact my profit or loss today,
[836]
while the green and red boxes represent
at expiration. For example, we can see our
[842]
breakeven for today is approximately 150. However,
at expiration, due to the effects of time decay,
[849]
itíll be about 138 and half, 138.35 to be
precise, not accounting for the transaction
[854]
costs. You can see the stock being anywhere
above there at expiration would be profitable,
[860]
though once we reach 140 both contracts expire
worthless and we hit max gain. In the other
[866]
direction, anywhere below 135 at expiration, both
options would be in the money and Iíd hit max loss
[873]
Letís go back up and place the trade. Iíll
click review and confirm the details are
[878]
correct. Note the transaction fee, in this case
3.90, or .65 per contract. Now Iíll click send.
[886]
Thereís the confirmation saying our orderís been
sent. Ok, weíve placed a short put vertical!
[892]
But this isnít a set it and forget it kind of
strategy. Weíve got to make sure weíre keeping
[896]
up with it. The way you manage these trades
can make or break them, so weíre going to
[900]
walk through managing some other sample short put
verticals that Iíve got in a paperMoney account.
[905]
But before we go through them, letís talk about
a simple rule that can guide how you manage your
[910]
short put spreads: If youíre more than five to
10 days from expiration, manage your winners.
[915]
If you have less time than that, manage your
losers. Let me explain what I mean. Set a profit
[921]
Target this could be something like 80% to 90%
of the max gain and then close your winners when
[926]
they reach that target, even if itís just a few
days after youíve placed the trade. If you get
[931]
to 10 days before expiration, start weighing
whether you should exit your losing trades.
[937]
Letís open up Nvidia, symbol NVDA.
Both of our strikes are out of the
[941]
money. Our original credit was
4.09, which is our maximum gain.
[946]
Our current unrealized gain is around $400,
leaving us with only about $9 of remaining profit.
[953]
We could let it ride and leave it open for
an extra 9 days, but that opens us up to the
[957]
risk of it turning downward, and we could
lose out on some gains. Since weíve already
[962]
achieved 98% of our max gain, Iím going to
close this trade to lock in that profit.
[968]
To close the position Iíll click the
symbol, which opens up more details.
[972]
The position is already selected, so I can click
close selected to bring up the order entry.
[977]
So you can see Iím selling the long put
and buying the short put for a debit of
[982]
8 cents. Iím going to nudge that to 9 cents
to increase my likelihood of getting filled.
[987]
Now Iím going to click review, where I can see the
cost of the trade, which includes $1.30 in fees.
[995]
Ok, letís go back to our positions and take a
look at another one. Iíve got a spread on Union
[1000]
Pacific, UNP, and you can see both options are
in the money. This is looking like a likely max
[1006]
loss scenario, and the risk of early
assignment on my short put is elevated.
[1011]
But Iíll give it one more day in hopes itíll
turn around and I can avoid max loss. Remember,
[1016]
if both options were to expire in the money, my
long put would help cap the loss on the short put.
[1021]
In any event Iíll close it tomorrow, whether
weíre further from max loss or closer to it,
[1026]
in order to salvage any remaining
value before expiration.
[1031]
Alright, letís look at one more sample trade to
answer the question, What happens if the stock
[1036]
lands between my strikes? So, on Pepsi you can
see I sold the Feb 12 142 put and bought the Feb
[1044]
12 137. Iíve only got 2 days to expiration, and
the stock is now just above 137, so the short put
[1052]
is in the money, but the long put hasnít been hit
yet. Weíre facing a potentially tricky scenario.
[1058]
I havenít hit max loss yet, but Iím definitely
at risk of assignment on the short put and my
[1063]
long put is still out of the money. If we hit
expiration in this scenario, the short put will be
[1069]
assigned, but the long put would expire worthless,
leaving us on the hook to buy 100 shares that we
[1074]
never intended to own. So, to avoid assignment,
Iím going to close the position for a loss.
[1080]
Iíll follow the same process as my earlier
trade that was a winner: click the symbol,
[1085]
click close selected. Iím going to leave it at the
mid price and review the details, which show Iím
[1090]
buying the vertical back at a cost of $350. At
expiration it could have cost as much at $500,
[1097]
so Iím preventing a max loss. Note the
transaction fee of $1.30. Now Iíll click send.
[1104]
There you go. Thatís the nuts and
bolts of the short put vertical.
[1107]
Or the bull put spread. Or the you get the idea.
[1111]
Remember, even though the approach we
discussed may be higher probability
[1114]
and less risky than others youíve seen
out there, itís still risky. Make sure
[1119]
you practice paper trading to get a
feel for how these trades can move.
[1123]
Be sure to check out our coaching webcasts too.
We have lots of options education that you should
[1128]
take advantage of because management
is such a huge part of trading options.
[1132]
To try out thinkorswim Web,
visit trade.thinkorswim.com.
[1137]
If you want to practice, make sure
you switch to paperMoneyÆ in the
[1141]
top left corner to get a handle
on how vertical spreads work.
[1144]
You can also download the
full thinkorswimÆ software,
[1146]
which weíve linked to in the description. We
have a ton of other education on our channel,
[1150]
so make sure you subscribe and hit the bell
to get notified when we upload new videos.
Most Recent Videos:
You can go back to the homepage right here: Homepage