What Is a Bear Put Spread: Learn in Detail
Aug 09, 2022 By Triston Martin

Introduction

What Is a Bear Put Spread? To use the Bear Put Spread strategy, the investor must purchase out-of-the-money put options (higher) and then trade an out-of-the-money (lower) option with the same company and exact expiration dates. This strategy puts the investor at risk of suffering a loss. The overall objective of the strategy is to reduce the cost of purchasing the Put and raise your breakeven point (Long Put). The strategy requires a bearish outlook because investors will only make money if the index/price falls. This is a low-risk, low-profit strategy.

Explanation

The strategy is also highly risk-averse. A price increase over ITM is an example of this. The amount of the loss is equal to the amount of the investment's debit. Both selling and buying put options have a net difference in value because they both expire worthlessly. When compared to the OTM and ITM options, the cost is higher. In this scenario, it is possible to lose money if the costs of establishing the position are higher than the difference between the strike costs.

In July this year, ABC stock was trading at around 100 rupees per share. A bearish trader creates the put spread on ABC. To make 300 rupees, the trader buys an August 110 Put and then sells a July 95 Put for 200 rupees. It will cost them Rs 100 to cover the position's funding needs. To put it another way, both options would be in the money if ABC's price ABC falls to around 90 at expiration, putting both options in the money for the trader. After subtracting the Rs. 100 fees for opening the account, the remaining balance is Rs. 10,000. The trader's profit would equal Rs 6,900 minus Rs 1,000 minus Rs 100, or Rs 4,900. As a result, both options would have been worthless, and the initial price of Rs 100 would have been a loss.

Exactly how does it work?

Let's look at an example with stock to understand this strategy better. Outlook is an excellent place to start. Price made a Dojiat to the resistance of 2800 after a long uptrend from the levels of 2163-2798. of 2800. The price began to fall after that. Secondly, you need a plan of action. Bear Put Spread Strategy involves:

  • Purchase Put at higher Prices for Strikes: In this scenario, we could purchase 2600 puts for around 38 of June's expiry date.
  • Selling Put of Lower Strike: We could sell 2500 puts at around 22 of June's Expiry.
  • Maximum Gain: Low strike, high strike net premium paid.
  • Maximum Loss: Net premiums paid. The shorter Put's strike is, the greater the chance of a maximum profit. However, that profit must be balanced against the drawback, which is a lower amount of premium paid.

It's interesting to contrast this strategy with the spread of bear calls. Profit/loss payoff rates are the same after being adjusted to reflect the cost of carrying. The significant difference is in the timing of cash flow. Bear put spread demands an upfront outlay of a tentative return in the future. The bear call spread generates an initial cash flow to be used for an eventual expenditure later.

Profit and Loss in a Bear Put Spread

The risk is low, and the reward. The maximum amount a trader can earn from a bear spread will be the difference in the strike prices after subtracting the amount paid for the more expensive strike put. The highest gain is when the asset being traded closes at a price at or below the strike price of the lower one at the expiration date.

In such a scenario, the trader uses his put option with a higher strike and sells shares at the more excellent strike price. If the stock is in the market, the lower strike price option is automatically exercised, and the trader then purchases stocks at a lower price. So, there isn't a Net stake in the stock created.

If the price is above or equal to the strike price of the higher option at the time of expiration, the options will expire without exercise. If the price of the stock is lower than the strike price that the upper strike options but not in the range of what the price is of the lesser strike, the Put with the higher strike is exercised, granting the trader a short position on the stock that is being traded.

Conclusion

The bear put spread can be described as an investment strategy used by an investor with an opposing view who wishes to maximize profits while minimizing losses. This strategy entails the simultaneous sale and purchase of put options for the same asset with the same expiration date but at different price points. A bear put spreads an income when the price of the security in question declines.