Strategy in brief: Buy put option with a higher strike and sell another put option with a lower strike, producing a net debit.
When to use this strategy: you think the stock will go down somewhat or at least is a bit more likely to fall than to rise.
Comments:
· Good position if you want to be in the stock but are unsure of bearish expectations.
· This is the most popular bearish strategy.
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Figure: Bear Put Spread Strategy Example
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Profit: limited, reaching maximum if stock ends at or below the lower strike at expiration. It is equal to difference between strikes minus initial debit. At expiration, break-even point will be higher strike minus initial debit.
Loss: reaches its maximum, if stock at expiration is at or above a higher strike. It is equal to net initial debit.
Risk: limited.
Reward: limited.
Time decay: if the stock is midway between strikes, no time effect. At higher strike, profits increase at the fastest rate with time. At lower strike, losses increase at the maximum rate with time.
Research Findings and Trading Tips:
Bear put spreads have the following advantages over bear call spreads:
a. You are not risking early exercise of short option.
b. Bear put spreads perform much better if the underlying stock drops quickly.
