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Bull Put Spread Option Strategy - Options Trading Strategies - Bullish Options Strategies - YouTube
Channel: Option Alpha
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Hello everyone. This is Kirk, here again at
optionalpha.com. And in this video tutorial,
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we're going to talk about the bull put spread.
So, starting with the market outlook as always,
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this is a little bit of a complex option strategy.
It's not the most complex, but it's not just
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your simple run-of-the-mill buying and selling
of puts and calls.
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So, the bull put spread option is entered
when the option trader thinks that the price
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of the underlying asset will go up moderately
in the near term. So, we're not all too crazy
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about being bullishness. We just think that
there's going to be a general rise in the
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price. We don't think it's going to double
in price in the next 30, 60 days. Now, traditionally,
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this is known as a put credit spread, since
the credits is received upon entering the
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trade, and then you hope you keep that entire
credit at expiration. Sorry for the typo there.
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Keep, keep. So again, this could be considered
one of your credit spread strategies. In this
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case, a put credit spread.
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So, how do you set this up, right? Again,
it's very easy. It only takes two options
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to set up this particular strategy, but this
is where the beauty of creating a strategy
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around the market comes into with options.
So, bull put spreads are implemented by selling
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an at the money put, while simultaneously
writing a lower strike out of the money put
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of the same underlying security and the same
expiration level. Very key there that the
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same expiration month.
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So in this example to the left with our profit
loss diagram, you're going to sell one 45
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strike put, and then you're going to buy one
40 strike put. So, you're going to sell the
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in the money and buy the out of the money.
Now, you can do this with two out of the money
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options. The key is that you want to sell
the higher priced put, and you want to buy
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the lower-priced put when you're doing a bull
put spread or a bull put credit spread. That's
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the real key there. So, these could be all
in the money, at the money, all out of the
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money. The key is that you want to sell a
higher strike and you want to buy the lower
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strike.
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Well, what's the risk with this strategy?
Well, as you can see on the chart, the maximum
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loss on this strategy is limited. The difference
between the strikes, less the credit received.
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So, the difference between your strike prices
45 to 40, less the credit that you receive
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on this. That is the maximum loss you can
take in. The worst that can happen is for
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the stock to be close lower than the lower
strike at expiration.
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So again, this lower strike here where the
loss diagram creates or starts the flat line
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here, your losses are capped right here at
$300. So, anything below 40, if the stock
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closes anywhere below 40, then your losses
are completely and 100% capped. You cannot
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lose a dime more, because in that case, both
put options expire in the money which creates
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the loss.
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So, if we talk about profit potential now,
we also notice that the top half of our profit
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loss diagram is also flat, meaning it's capped
to the upside. It doesn't continue on in perpetuity.
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The maximum gain on these are capped. The
ideal scenario would be to see the stock close
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above the higher strike price, so anywhere
from 45 higher. In which case, both put options
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expire worthless and you pocket the credit.
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Again, remember that a bull put spread is
just a credit spread. It's just a put credit
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spread. So, with a credit spread and/or any
option strategy where you receive a credit
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initially, you do want all of those options
to ideally expire worthless. In which case,
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you keep 100% of that credit. So, closing
between the strikes though, results in variable
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gains or losses. So, if we close anywhere
along this diagonal line here, you could have
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a loss or you could have a small gain either
one.
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When we talk about volatility, volatility
on this particular strategy is going to be
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fairly low. Since the strategy involves being
long one put and short one put of the same
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expiration period, the effects of volatility
are going to really offset each other to a
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large degree. So, if you have a positive volatility
move here and a negative volatility move here,
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for more or less, they're going to offset
each other. There's going to be a slight difference
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because you are selling and buying at different
strike prices. But again, it's only going
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to be a very small difference. You're going
to have a greater impact on actual underlying
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price of the stock.
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With time decay, it's the same sort of thing
as volatility. So, the passage of time decay
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was generally going to help the strategy since
it is a short option strategy or an option
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selling strategy. And we do want all the options
to expire worthless at expiration. But just
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like volatility with two put options, the
effect of time decay on the both contracts
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are going to offset each other. So, where
you gain money and time decay on one option,
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you're going to lose it on the other one
more or less.
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With breakeven points on this bull put spread,
the strategy breaks even if at expiration,
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the stock price is below the upper strike
(so again, this is the short strike price
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or the short put option) by the amount of
the initial premium. So, you can see that
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our strike price on the upper strike is 45,
so the breakeven point would be 45, less the
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initial premium that we received. That would
create this area here at 43 which would be
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virtually where our option breaks even.
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Let's look at an example just to really drive
it home here. So, we have a stock price that's
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trading at about 43. So, let's just say a
stock is trading right here. We're going to
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buy one 40 strike put for $100. Again, down
here. We're going to buy this one for $100
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and we're going to sell this one 45 strike
put for $300. So, the net difference between
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those two (we outlaid $100, we took in $300)
is a credit or money that we received directly
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into our account of $200. And you can see
that that is where our profit is actually
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capped on the top side. Now, our max loss
is actually $300. Again, it's the strike price
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minus the credit. So, 45 minus 200 is going
to be that $300 loss. And again, we have - This
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maximum profit is not calculated correctly.
But our maximum profit is actually $200 or
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the net credit that we received.
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Some tips and tricks for bull put spreads
or bull put credit spreads. The more out of
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the money your strike prices, the more conservative
your position. So again, in this example,
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we sold these strategy here right at the money,
but you don't have to do that. If the market
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is trading at 43, you can sell these all the
way out, possibly down to 20, 25 in that type
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of area. So, higher credits don't necessarily
mean it's a better position to have. Generally
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speaking, you're going to see an at the money
position that's basically a 50/50 flip where
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you're going to make about the same as you
are going to lose. So, it's just the same
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as trading the underlying stock.
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So, you do want to have some sort of direction
on the market and have some sort of opinion.
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You don't just want to trade these and think
you're going to take in money every time,
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but you want to have some sort of direction
on the market. So, the more out of the money
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you are, the less your credit is going to
be or the less premium you're going to receive,
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but the more likelihood is that you're going
to keep that premium, since it's far out of
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the money.
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So, if you're having trouble filling these
positions, try legging into the spread. A
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lot of option brokers will try to have you
enter these at the same time. So, it'll have
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you simultaneously place an order to sell
the 45 and simultaneously place an order to
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buy the 40. And when you do that, you have
to have exact fills on all of this. But try
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legging into it. So, you buy or sell individually
these legs and create the position by the
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end of the day.
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So as always, I hope you guys really enjoyed
these videos. As always, if you liked the
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