Saturday 26 May 2012

Bull Put Spread

Outlook: Bullish or Neutral to Bullish

Bull Put Spread - Buy lower strike Put, Sell higher strike Put

Strategies...
  • Buy lower strike put
  • Sell same number of higher strike puts with the same expiration date.
  • Ensure trend is upward
  • Preferably with one month or less to expiration
Example...

VeriFone Systems Inc (NYSE:PAY) is trading at $38 on May 26, 2012.

  •     Buy the Jun 2012 $33 put option for $0.35.
  •     Sell the Jun 2012 $37 put option for $1.20.

Bull Put Spread


















Why Buy Jun $33 Put? You have right to sell the stock at $33 if stock price fall. 

Why Sell Jun $37 Put? Capped downside risk. Jun $37 Put will not be exercised if price fall lower than $37.

How does Bull Put Spread work?

Stock price rise to $40.00...(or higher)


  •     Buy the Jun 2012 $33 Put = Out-of-the-money, $0
  •     Sell the Jun 2012 $37 Put = Put not exercise, premium gain=$1.20
  •     Net premium gain: $ 1.20 - $0.35 = $0.85 
  •     Profit: $0.85


Stock price at $36.15...

  •     Buy the Jun 2012 $33 Put = at-the-money, $0
  •     Sell the Jun 2012 $37 Put = Put exercised, loss $0.85
  •     Net premium gain: $ 1.20 - $0.35 = $0.85
  •     Profit : $0


Stock Price fall to $30...

  •     Buy the Jun 2012 $33 Put = In-the-money, gain $3
  •     Sell the Jun 2012 $37 Put = Put exercised, loss $7
  •     Net premium gain: $ 1.20 - $0.35 = $0.85
  •     Profit : $3-$7+$0.85= -$3.15
  •  
Bull Put Spread


Advantages...
  • Short-term immediate income, net premium = $0.85,
  • Capped downside protection. (No matter how further price goes down, maximum loss in Buying and Selling Put is locked to the difference in strikes $37-$33=$4)

Disadvantage...
  • Capped upside if the stock rises.(No matter how high stock price rise, you maximum profit cap to net premium gain=$0.85)

Maximum Profit:    $1.20-$0.35=$0.85
                              (premium received - premium paid = net premium gain)

Maximum Loss:     $37-$33+$0.85=$3.15
                              (Different in strike + net premium gain)          

Breakeven:           $37-$0.85=$36.15
                              (Higher strike - net premium gain)


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