When an investor is bearish on a particular stock, but does not want to sell the shares outright, they may use put options to hedge their position. This can be done by buying a put option, which gives the investor the right to sell their shares at a predetermined price, or by selling a put option, which obligates the seller to buy the shares at a predetermined price.
A put credit spread is when an investor sells one put option and buys another with a higher strike price. This spread results in a net credit to the investor and provides some downside protection if the stock price falls below the lower strike price of the sold put option. If the stock price falls below both strike prices, then the investor would be obligated to buy shares at the higher strike price and sell them at the lower strike price, resulting in a loss.
Bull Put Credit Spread Setup
A bull put credit spread is a bullish options strategy that is entered by buying a put option and selling a higher strike put option of the same expiration date. The goal of this strategy is to profit from a rise in the price of the underlying security while limiting the amount of capital at risk.
The maximum gain with this strategy is achieved when the underlying security closes at or above the sold strike price at expiration. In this case, the investor would earn the difference between the prices of the two contracts, less any commissions or fees. If the underlying security falls below the sold strike price, then the investor could lose up to the amount he paid for the original put option contract.
This strategy can be used when an investor expects a moderate rise in prices and wants to limit their downside risk.
An Example of a Put Credit Spread or Bull Put Spread
When you are trading options, there are a variety of different strategies that you can use in order to make money. One of these strategies is the put credit spread or bull put spread. This strategy involves selling a put option and buying another put option with a higher strike price.
This strategy is used when you think the stock is going to go up in price. By selling the put option, you are collecting the premium and by buying the other put option, you are limiting your losses if the stock does go down in price.
Calculating Max Profit and Max Loss for Put Credit Spreads
There are a few key calculations when trading put credit spreads: the maximum profit and the maximum loss. The maximum profit is simply the net credit received when entering the spread. The maximum loss is the worst-case scenario, which is reached if the underlying stock falls to zero.
To calculate the maximum profit, we need to know two things: how much we’re paid for entering the spread and where the underlying stock will close at expiration.
For example, if we receive $0.50 for entering a put credit spread with an underlying stock at $50, our maximum potential profit would be $0.50 per share (less commissions). If the underlying stock falls to $0.00 at expiration, we would lose our entire investment of $0.50 per share (again, less commissions).
Assignment Risk With Put Credit Spreads
When you purchase a put credit spread, you are hoping that the stock will drop in price and your short put option will expire worthless. If the stock does not decrease in price, or if it increases in price, you could be assigned on your long put option, which would require you to purchase the stock at the current market price.
This could result in a loss on the position if the stock decreases in price by less than the premium received for entering into the spread.
Managing Risk With Put Credit Spreads
When you buy a put, you have the right, but not the obligation, to sell a security at a set price. When you sell a put, you have the obligation to buy the security at a set price. This is also called writing a put.
A put credit spread is created when you sell one put and buy another with a higher strike price. The goal of this strategy is to collect premium from the sale of the lower-strike put and hope that the stock stays above that strike price. If the stock falls below the lower strike price, then your losses are limited to the amount of premium collected on the sale of the lower-strike put.
