Bear Put Spread

What Is a Bear Put Spread?

A bear put spread is a type of options strategy where an investor or trader anticipates that a moderate should huge decline in the price of a security or asset and needs to reduce the cost of holding the option trade. A bear put spread is accomplished by purchasing put options while likewise selling similar number of puts on a similar asset with the equivalent expiration date at a lower strike price. The maximum profit utilizing this strategy is equivalent to the difference between the two strike prices, minus the net cost of the options.

A put option gives the holder the right, however not the obligation, to sell a predetermined amount of underlying security at a predefined strike price, at or before the option lapses.

A bear put spread is otherwise called a debit put spread or a long put spread.

The Basics of a Bear Put Spread

For instance, we should expect that a stock is trading at $30. An options trader can utilize a bear put spread by purchasing one put option contract with a strike price of $35 for a cost of $475 ($4.75 x 100 offers/contract) and selling one put option contract with a strike price of $30 for $175 ($1.75 x 100 offers/contract).

In this case, the investor should pay a total of $300 to set up this strategy ($475 - $175). If the price of the underlying asset closes below $30 upon expiration, the investor will understand a total profit of $200. This profit is calculated as $500, the difference in the strike prices ($35 - $30) x 100 offers/contract - $300, the net price of the two contracts [$475 - $175] equals $200.

Advantages and Disadvantages of a Bear Put Spread

The principal advantage of a bear put spread is that the net risk of the trade is reduced. Selling the put option with the lower strike price assists offset the cost of purchasing the put option with the higher strike price. Subsequently, the net outlay of capital is lower than buying a single put outright. Additionally, it conveys undeniably less risk than shorting the stock or security since the risk is limited to the net cost of the bear put spread. Selling a stock short hypothetically has unlimited risk if the stock moves higher.

In the event that the trader accepts the underlying stock or security will fall by a limited amount between the trade date and the expiration date then a bear put spread could be an optimal play. In any case, in the event that the underlying stock or security falls by a greater amount, the trader provides up the ability to claim that extra profit. It is the trade-off among risk and potential reward that is interesting to numerous traders.

Pros

Less risky than simple short-selling
Works well in modestly declining markets
Limits losses to the net amount paid for the options

Cons

Risk of early assignment
Risky if asset climbs dramatically
Limits profits to difference in strike prices

With the model over, the profit from the bear put spread maximizes assuming that the underlying security closes at $30, the lower strike price, at expiration. On the off chance that it closes below $30 there won't be any extra profit. On the off chance that it closes between the two strike prices there will be a reduced profit. Furthermore, on the off chance that it closes over the higher strike price of $35 there will be a loss of the whole amount spent to buy the spread.

Likewise, similarly as with any short position, options-holders have no control over when they will be required to satisfy the obligation. There is consistently the risk of early task — that is, having to buy or sell the designated number of the asset at the settled upon price in fact. Early exercise of options frequently occurs if a merger, takeover, special dividend, or other news happens that influences the option's underlying stock.

Genuine Example of Bear Put Spread

For instance, suppose that Levi Strauss and Co. (LEVI) is trading at $50 on October 20, 2019. Winter is coming, and you don't think the pants creator's stock will flourish. All things being equal, you think it will be somewhat depressed. So you buy a $40 put, priced at $4, and a $30 put, priced at $1. The two contracts will lapse on November 20, 2019. Buying the $40 put while simultaneously selling the $30 put would cost you $3 ($4 - $1).

In the event that the stock closed above $40 on November 20, your maximum loss would be $3. Assuming it closed under or at $30, be that as it may, your maximum gain would be $7 — $10 on paper, yet you need to deduct the $3 for the other trade and any broker commission fees. The break-even price is $37 — a price equivalent to the higher strike price minus the net debt of the trade.

Features

A bear put spread strategy includes the simultaneous purchase and sale of puts for a similar underlying asset with a similar expiration date however at various strike prices.
A bear put spread is an options strategy carried out by a bearish investor who needs to boost profit while limiting losses.
A bear put spread nets a profit when the price of the underlying security declines.