What is Bear Put Spread?
Bear Put Spread is a kind of options strategy or tactic in which a trader or investor anticipates a slight reduction in the price of an asset or security. A bear put spread is attained by buying put options while also selling the same quantity of puts on the same asset with the same expiration date at a lower target price. The maximum profit a trader can achieve under this strategy is the difference between the two strike prices, minus the total cost of the options.
The most interesting thing about this options strategy is that profit remains restricted if the stock price drops below the strike price of the short put known as the lower strike, and at the same time, the possible loss is also restricted if the stock price goes beyond the strike price of the long put called higher strike.
One thing to keep in mind that an option refers to authority without the compulsion to sell a stated amount of corresponding security at an itemized strike price.
- A bear put spread refers to an options strategy that is usually adopted by an aggressive trader or investor who’s willing to optimize profit while reducing losses.
- A bear put spread strategy encompasses the synchronized purchase and sale of put options regarding the same underlying asset with the same expiration date at different strike prices.
- A bear put spread yields a profit when the price of the underlying security reduces.
Pros and Cons of A Bear Put Spread
The primary benefit of a bear put spread is that it brings down the total risk associated with the trade. Selling the put option with the reduced strike price helps counterbalance the value of buying the put option at the higher strike price. Thus, the net outlay of capital is inferior to purchasing a single put directly. Additionally, it features a much lesser risk than shorting the stock or security as the risk carries a max cap which is the net cost of the bear put spread. Selling a stock short hypothetically carried limitless risk if the stock trends higher.
If the trader thinks that the original stock or security will go down by a fixed amount between the trade date and the ending date then a bear put spread could be a great option. But, if the underlying stock or security falls by a higher amount then the trader leaves the ability to claim that extra gains. It is the trade-off between risk and possible gain that lures most traders.
- Carries less risk as compared to short-selling
- Performs well in mildly declining markets
- Restricts losses at the total amount paid for options
- The peril of early task
- Threatful if asset rises awkwardly
- Restricts profits to variation in strike prices
In case of any short position, options-holders take no authority over when they will be needed to meet the obligation. There is always the danger of initial assignment—that is, having to buy or sell the chosen number of the asset at the decided price. Initial workout of options often occurs if a merger, seizure, dividend, or other news happens that influences the option’s primary stock.
When to choose a bear put spread?
According to investment experts, it is a great idea to opt for this strategy when the price of the key stock drops below the strike price at the time of expiration. Overall, it can be said that the best prediction is “mildly bearish.”
Bear put spreads carries controlled profit probability, but they cost less than buying only the higher strike put. Since most stock price variations are “negligible,” bear put spreads, theoretically, have a greater chance of making a larger percentage profit than buying only the higher strike put. Practically, however, going with a bear put spread rather than purchasing just the higher strike put is a personal choice. Bear put spreads advantage from two aspects, a dropping stock price and time decline of the short option. A bear put spread is the most effective options strategy when the forecast is for a continuous price reduction to the strike price of the short put.
The strategy is also known as “debit put spread” strategy and a “long put spread.” The term “bear” refers to the fact that the strategy profits with bearish, or falling, stock prices. The term “debit” directs to the point that the strategy is suitable for the total cost, or net debit. Lastly, the term “long” means that this strategy is “bought,” which usually means that it is designed for a net cost.