Bull Put Spread Options Trading Strategy: Definition, How to Trade it

A bull put spread is a slightly bullish options strategy that is constructed by selling a put option with a higher strike price (closer to at-the-money) and simultaneously buying a put option with a lower strike price. This spread is initiated for a net credit, because the premium collected from the higher strike put is greater than the premium outlaid for the lower strike put. 

From that perspective, this spread may also be referred to as a “short put spread.” This strategy aims to profit from a moderately bullish or neutral market outlook, with both limited risk and limited profit potential.

The bull call spread is technically a form of vertical spread. Vertical spreads are options strategies that involve opening long (buying) and short (selling) positions simultaneously, with the same underlying asset and expiration, but with different strike prices. With a vertical spread, both of the options must be of the same type - both puts or both calls. 

There are four types of vertical spreads, and the bull put spread is one of them. The other three vertical spreads are the bull call spread, the bear call spread, and the bear put spread. These spreads are sometimes referred to as a short put vertical (bull put spread), a long put vertical (bear put spread), a short call vertical (bear call spread), and a long call vertical (bull call spread). 

A bull put spread is constructed by selling a put option with a higher strike price (closer to at-the-money) and simultaneously buying a put option with a lower strike price, with both options expiring on the same date. 

This spread is initiated for a net credit, because the premium collected from the higher strike put is greater than the premium outlaid for the lower strike put. This strategy aims to profit from a moderately bullish, or neutral market outlook, with both limited risk and limited profit potential.

More details on the bull put spread are outlined below.

Basic Concept of Vertical Spreads

• Vertical spreads entail the simultaneous buying and selling of options of the same type (calls or puts) with identical expiration dates but differing strike prices. 

• These strategies are distinguished by their vertical arrangement on an options chain.

Structure of a Bull Put Spread

• In a bull put spread, the trader sells a put option with a higher strike price while concurrently buying a put option with a lower strike price.

• Both options have the same expiration date, creating a net credit for the trader.

Profit Potential

• The goal of a bull put spread is to profit from a moderately bullish, or neutral market outlook.

• The maximum profit is realized if the price of the underlying asset remains above the higher strike put option at expiration, causing both options to expire worthless.

• In this scenario, the trader keeps the entire net credit received.

Maximum Gain

• The maximum gain is the net credit received when entering the trade.

• This occurs if the price of the underlying asset remains above the higher strike put at expiration.

Maximum Loss

• The maximum loss is the difference in strike prices minus the net credit received.

• This occurs if the price of the underlying asset falls below the lower strike put at expiration.

Breakeven Point

• The breakeven point is the strike price of the sold put minus the net credit received.

• The trade will be profitable as long as the price of the underlying asset remains above this level at expiration.

In the following examples, imagine that an investor or trader is slightly bullish on the underlying, and decides to deploy a bull put spread, because this trade structure tends to benefit from a slightly bullish move in the underlying. 

The two examples outlined below help illustrate how the risk-reward profile of a bull put spread shifts when different strikes are selected for the spread. 

Example 1

Initial Position

• Stock XYZ is trading at $50 per share.

• The investor expects the price of XYZ to rise moderately.

• The investor sells 1 put option with a strike price of $50 for a premium of $3 per share.

• The investor simultaneously buys 1 put option with a strike price of $45 for a premium of $1.50 per share.

Maximum Gain

• The investor receives a net premium of $1.50 per share ($3 received for the $50 put option - $1.50 paid for the $45 put option).

• The maximum gain is the net premium received: $150 (since each contract represents 100 shares, $1.50 x 100 = $150).

Maximum Loss

• The maximum loss occurs if the stock price is below the lower strike price of $45 at expiration.

• The net premium received reduces the maximum loss by $1.50 per share.

• Maximum loss per contract: ($50 - $45 - $1.50) x 100 = -$350.

Preferred Outcome

• In this example, the preferred stock price at expiration is $50 or higher. 

• If the stock price remains above $50 at expiration, both options expire worthless, allowing the investor to keep the net premium received. 

Example 2

Initial Position

• Stock XYZ is trading at $50 per share.

• The investor expects the stock price to rise moderately. 

• The investor sells 1 put option with a strike price of $45 for a premium of $2 per share.

• The investor simultaneously buys 1 put option with a strike price of $40 for a premium of $0.75 per share.

Maximum Gain

• The investor receives a net premium of $1.25 per share ($2 received for the $45 put option - $0.75 paid for the $40 put option).

• The maximum gain is the net premium received: $125 (since each contract represents 100 shares, $1.25 x 100 = $125).

Maximum Loss

• The maximum loss occurs if the stock price is below the lower strike price of $40 at expiration.

• The net premium received reduces the maximum loss by $1.25 per share.

• Maximum loss per contract: ($45 - $40 - $1.25) x 100 = -$375.

Preferred Outcome

• In this example, the preferred stock price at expiration is $45 or higher. 

• If the stock price remains above $45 at expiration, both options expire worthless, allowing the investor to keep the net premium received. 

As with any options-focused trading strategy, there are pros and cons associated with the bull put spread. Some of the advantages of the bull put spread are outlined below:

• Defined Risk: One of the primary advantages of the bull put spread is that it offers limited risk. As a result of its defined-risk nature, the maximum potential loss of a bull put spread is predefined, and limited to the difference in strike prices minus the net credit received.

• Defined Maximum Profit: The maximum profit potential of the bull put spread is also predefined. Traders know the exact amount they can potentially gain from the trade, which is the net credit received when entering the position.

• Income Generation: Bull put spreads are often utilized as income-generating strategies. Traders can collect options premium by selling the higher strike put option, which helps to offset the cost of purchasing the lower strike put option.

• Bullish or Neutral Outlook: The bull put spread can be profitable in a bullish market, or even in a neutral market scenario, where the price of the underlying asset remains relatively stable, or moves slightly higher.

• Versatility: Traders can adjust the structure of the bull put spread by selecting different strike prices and expiration dates based on their outlook and risk tolerance. This flexibility allows for customization of the strategy to suit specific market expectations and trading objectives.

As with any options-focused trading strategy, there are pros and cons associated with the bull put spread. Some of the disadvantages of the bull put spread are outlined below:

• Limited Profit Potential: While the bull put spread offers limited risk, it also comes with limited profit potential. The maximum profit is capped at the net credit received, which may be lower compared to the potential gains from other more aggressive strategies.

• Breakeven Point: To achieve profitability, the price of the underlying asset must remain above the breakeven point, which is the strike price of the sold put option minus the net credit received. If the price falls below this level, the trade will incur a loss. 

• Margin Requirements: Depending on the broker and the specific requirements, initiating a bull put spread may tie up a certain amount of margin. Traders should be aware of these margin requirements and manage accordingly.

• Potential Assignment Risk: Traders should be prepared to handle assignment risk if it arises.

• Market Risk: Like all trading strategies, the bull put spread is subject to market risk. Unforeseen events or sudden changes in market conditions can impact the profitability potential of the trade. 

The preferred outcome for a bull put spread is for the price of the underlying asset to remain above the higher strike put option (the short put) at expiration. In this scenario, both options expire worthless, allowing the trader to keep the net premium received. This outcome also results in the maximum profit.

On the other hand, if the price of the underlying falls below the lower strike put option at expiration, the position will incur the maximum loss. However, the maximum loss is limited to the difference in strike prices minus the net credit received.

The maximum profit and maximum loss are summarized below.

Maximum Profit

• The maximum profit for a bull put spread is achieved if the price of the underlying asset remains above the higher strike put option at expiration.

• The maximum profit is equal to the net credit received when entering the trade.

• In this scenario, both options expire worthless. 

• Formula: Maximum Profit = Net Credit Received

Maximum Loss

• The maximum loss for a bull put spread is incurred if the price of the underlying asset falls below the lower strike put option at expiration.

• The maximum loss is capped at the difference in strike prices minus the net credit received.

• Formula: Maximum Loss = Difference in Strike Prices - Net Credit Received

Both a bull call spread and a bull put spread are a type of vertical spread. The primary differences between a bull call spread and a bull put spread lie in the types of options used and the expected magnitude of movement in the underlying. 

A bull call spread involves buying a call option with a lower strike price and simultaneously selling a call option with a higher strike price, with the expectation of benefiting from a bullish market outlook. Conversely, with a bull put spread, the trader sells a put option with a higher strike price and buys a put option with a lower strike price, aiming to profit from a moderately bullish, or neutral market outlook.

While both strategies offer limited risk and limited profit potential, the preferred outcomes differ. For a bull put spread, the ideal scenario is for the underlying asset to remain above the higher strike put option at expiration, resulting in the maximum profit. In contrast, for a bull call spread, the desired outcome is for the underlying asset to rise above the higher strike call option at expiration, which also results in the maximum profit. 

In short, the bull put spread benefits from slightly bullish movement in the underlying (or even sideways movement), while the bull call spread tends to benefit from a more significant upside move in the underlying. Ultimately, the choice between these strategies depends on factors such as market conditions, risk tolerance, and the trader's outlook on the underlying asset.

A bull put spread involves selling a put option with a higher strike price and simultaneously buying a put option with a lower strike price. This structure aims to generate income while managing risk, making it suitable for traders with a moderately bullish or neutral market outlook. 

The bull call spread is technically a form of vertical spread. Vertical spreads are options strategies that involve opening long (buying) and short (selling) positions simultaneously, with the same underlying asset and expiration, but with different strike prices. With a vertical spread, both of the options must be of the same type - both puts or both calls. 

The preferred outcome for a bull put spread is for the price of the underlying asset to remain above the higher strike put option (the short put) at expiration. In this scenario, both options expire worthless, allowing the trader to keep the net premium received. This outcome also results in the maximum profit.

On the other hand, if the price of the underlying falls below the lower strike put option at expiration, the position will incur the maximum loss. However, the maximum loss is limited to the difference in strike prices minus the net credit received.. 

Investors and traders may also want to consider the impact of volatility on a bull put spread before initiating this type of position. Generally speaking, a decrease in implied volatility tends to benefit the bull put spread. That’s because a decrease in implied volatility tends to benefit the short put option more than the long put option (due to their relative vega components), potentially benefiting the overall value of the spread before expiration. On the other hand, an increase in implied volatility may have the opposite effect. 

Another consideration with vertical spreads is the impact from time decay. As the options approach their expiration date, their extrinsic value typically diminishes. This natural decay may benefit the short put more than the long put (due to their relative theta components), especially if the underlying asset's price remains stable or increases as expected. Therefore, traders need to be mindful of time decay when choosing the strikes and expiration dates for the options in the spread.