Bull Spreads Explained

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Bull Call Spread

What Is a Bull Call Spread?

A bull call spread is an options trading strategy designed to benefit from a stock’s limited increase in price. The strategy uses two call options to create a range consisting of a lower strike price and an upper strike price. The bullish call spread helps to limit losses of owning stock, but it also caps the gains. Commodities, bonds, stocks, currencies, and other assets form the underlying holdings for call options.

How To Manage A Bull Call Spread

The Basics of a Call Option

Call options can be used by investors to benefit from upward moves in a stock’s price. If exercised before the expiration date, these trading options allow the investor to buy shares at a stated price—the strike price. The option does not require the holder to purchase the shares if they choose not to. Traders who believe a particular stock is favorable for an upward price movement will use call options.

The bullish investor would pay an upfront fee—the premium—for the call option. Premiums base their price on the spread between the stock’s current market price and the strike price. If the option’s strike price is near the stock’s current market price, the premium will likely be expensive. The strike price is the price at which the option gets converted to the stock at expiry.

Should the underlying asset fall to less than the strike price, the holder will not buy the stock but will lose the value of the premium at expiration. If the share price moves above the strike price the holder may decide to purchase shares at that price but are under no obligation to do so. Again, in this scenario, the holder would be out the price of the premium.

An expensive premium might make a call option not worth buying since the stock’s price would have to move significantly higher to offset the premium paid. Called the break-even point (BEP), this is the price equal to the strike price plus the premium fee.

The broker will charge a fee for placing an options trade and this expense factors into the overall cost of the trade. Also, options contracts are priced by lots of 100 shares. So, buying one contract equates to 100 shares of the underlying asset.

Key Takeaways

  • A bull call spread is an options strategy used when a trader is betting that a stock will have a limited increase in its price.
  • The strategy uses two call options to create a range consisting of a lower strike price and an upper strike price.
  • The bullish call spread can limit the losses of owning stock, but it also caps the gains.

Building a Bull Call Spread

The bull call spread reduces the cost of the call option, but it comes with a trade-off. The gains in the stock’s price are also capped, creating a limited range where the investor can make a profit. Traders will use the bull call spread if they believe an asset will moderately rise in value. Most often, during times of high volatility, they will use this strategy.

The bull call spread consists of steps involving two call options.

  1. Choose the asset you believe will appreciate over a set period of days, weeks, or months.
  2. Buy a call option for a strike price above the current market with a specific expiration date and pay the premium. Another name for this option is a long call.
  3. Simultaneously, sell a call option at a higher strike price that has the same expiration date as the first call option. Another name for this option is a short call.

By selling a call option, the investor receives a premium, which partially offsets the price they paid for the first call. In practice, investor debt is the net difference between the two call options, which is the cost of the strategy.

Realizing Profits From Bull Call Spreads

The losses and gains from the bull call spread are limited due to the lower and upper strike prices. If at expiry, the stock price declines below the lower strike price—the first, purchased call option—the investor does not exercise the option. The option strategy expires worthlessly, and the investor loses the net premium paid at the onset. If they exercise the option, they would have to pay more—the selected strike price—for an asset that is currently trading for less.

If at expiry, the stock price has risen and is trading above the upper strike price—the second, sold call option—the investor exercises their first option with the lower strike price. Now, they may purchase the shares for less than the current market value.

However, the second, sold call option is still active. The options marketplace will automatically exercise or assign this call option. The investor will sell the shares bought with the first, lower strike option for the higher, second strike price. As a result, the gains earned from buying with the first call option are capped at the strike price of the sold option. The profit is the difference between the lower strike price and upper strike price minus, of course, the net cost or premium paid at the onset.

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With a bull call spread, the losses are limited reducing the risk involved since the investor can only lose the net cost to create the spread. However, the downside to the strategy is that the gains are limited as well.

Investors can realize limited gains from an upward move in a stock’s price

A bull call spread is cheaper than buying an individual call option by itself

The bullish call spread limits the maximum loss of owning a stock to the net cost of the strategy

The investor forfeits any gains in the stock’s price above the strike of the sold call option

Gains are limited given the net cost of the premiums for the two call options

A Real World Example of a Bull Call Spread

An options trader buys 1 Citigroup Inc. (C) June 21 call at the $50 strike price and pays $2 per contract when Citigroup is trading at $49 per share.

At the same time, the trader sells 1 Citi June 21 call at the $60 strike price and receives $1 per contract. Because the trader paid $2 and received $1, the trader’s net cost to create the spread is $1.00 per contract or $100. ($2 long call premium minus $1 short call profit = $1 multiplied by 100 contract size = $100 net cost plus, your broker’s commission fee)

If the stock falls below $50, both options expire worthlessly, and the trader loses the premium paid of $100 or the net cost of $1 per contract.

Should the stock increase to $61, the value of the $50 call would rise to $10, and the value of the $60 call would remain at $1. However, any further gains in the $50 call are forfeited, and the trader’s profit on the two call options would be $9 ($10 gain – $1 net cost). The total profit would be $900 (or $9 x 100 shares).

To put it another way, if the stock fell to $30, the maximum loss would be only $1.00, but if the stock soared to $100, the maximum gain would be $9 for the strategy.

Bull Put Spread Explained (Best Guide w/ Examples)

October 11, 2020 By Chris

Bull Put Spread Explained – The Ultimate Guide

A bull put spread is an options strategy that consists of selling a put option while also buying a put option at a lower strike price.

Both options must be in the same expiration cycle. Additionally, each strike should have the same number of contracts (i.e. if selling two puts, two puts at a lower strike should be bought). Selling put spreads is similar to selling naked puts, but far less risky due to buying a put against the short put. As the name suggests, a bull put spread is a bullish strategy, as it tends to profit when the underlying stock price rises.

Bull Put Spread Strategy Characteristics

Let’s go over the strategy’s general characteristics:

Max Profit Potential: Net Credit Received x 100

Max Loss Potential: (Width of Put Strikes – Credit Received) x 100

Expiration Breakeven: Short Put Strike – Credit Received

Other Known Aliases: Short Put Spread, Put Credit Spread

To gain a better understanding of each concept, let’s walk through a trade example.

Profits/Losses at Expiration for a Bull Put Spread

In the following example, we’ll construct a bull put spread from the following option chain:

Strike Price

Put Price

To construct a bull put spread, we’ll have to simultaneously sell one of these puts and purchase the same number of puts at a lower strike price. In this case, we’ll sell the 90 put and buy the 85 put. Let’s also assume that the stock price is $90 when selling the spread.

Initial Stock Price: $90

Short Put Strike: $90

Long Put Strike: $85

Premium Collected for the 90 Put: $5.09

Premium Paid for the 85 Put: $2.84

In this example, selling the 90 put for $5.09 and buying the 85 put for $2.84 results in a net credit received of $2.25 (since $5.09 is collected, and $2.84 is paid). Additionally, the “spread width” is the difference between the long and short put strike, which is $5 in this case. Based on a net credit of $2.25 on a $5-wide bull put spread, here are the position’s characteristics:

Max Profit Potential: $2.25 Credit x 100 = $225

Max Loss Potential: ($5-Wide Strikes – $2.25 Credit) x 100 = $275

Expiration Breakeven Price: $90 Short Put Strike – $2.25 Credit = $87.75

Probability of Profit:

This bull put spread example has a probability of profit slightly greater than 50% because the breakeven price is less than the initial stock price, which means the stock price can fall slightly and the position can still profit. Additionally, the maximum loss potential is greater than the maximum profit potential.

Position After Expiration

If the stock price is below 85 at expiration, both puts expire in-the-money. At expiration, an in-the-money long put expires to -100 shares, and an in-the-money short put expires to +100 shares, which nets out to no stock position for the put spread seller. If the stock price is between 90 and 85 at expiration, only the short put expires in-the-money, resulting in a position of +100 shares for the short put spread trader.

The following visual demonstrates the potential profits and losses for this bull put spread at expiration:

Stock Price Above the Short Put Strike ($90):

Both the 85 and 90 put expire worthless. The profit on the short 90 put is $509, but the loss on the long 85 put is $284, resulting in a net profit of $225.

Stock Price Between the Short Put Strike ($90) and the Bull Put Spread’s Breakeven Price ($87.75):

The short 90 put expires with intrinsic value, but not more than the $2.25 credit received for the short put spread. Because of this, the bull put spread trader realizes a profit, but not the maximum profit since the position expires with some value.

Stock Price Between the Bull Put Spread’s Breakeven Price ($87.75) and the Long Put Strike ($85):

The short 90 put expires with more intrinsic value than the $2.25 credit the put spread trader collected when selling the spread. Because of this, the trader realizes a loss at expiration, but not the maximum loss.

Stock Price Below the Long Put Strike ($85):

The value of the $5-wide short put spread is $5. Since the spread was sold for $2.25, the trader realizes the maximum loss of $275.

Nice! You know how to determine the potential outcomes of a short put spread at expiration, but what about before expiration? To demonstrate how short put spreads perform before expiration, we’re going to look at a few examples of positions that recently traded in the market.

Bull Put Spread Trade Examples

In the following examples, we’ll compare changes in the stock price to a bull put spread on that stock. Note that we won’t discuss the specific stock the trade was on, as the same concepts regarding short put spreads apply to each stock. Additionally, each example represents one short put spread. The potential gains and losses scales proportionately to the number of put spreads traded.

Trade Example #1: Maximum Loss Bull Put Spread

The first example we’ll investigate is a situation where a trader sells an at-the-money put spread. An at-the-money bull put spread consists of selling an at-the-money put and buying an out-of-the-money put. When constructed properly, the breakeven price is slightly below the current stock price. Here’s the setup:

Initial Stock Price: $109.96

Strikes and Expiration: Short 110 put expiring in 46 days. Long 95 put expiring in 46 days.

Net Credit Received: $9.22 received for the 110 put – $3.67 paid for the 95 put = $5.55.

Breakeven Stock Price: $110 short put strike – $5.55 net credit received = $104.45.

Maximum Profit Potential: $5.55 net credit x 100 = $555.

Maximum Loss Potential: ($15-wide put strikes – $5.55 credit received) x 100 = $945.

Let’s see what happens!

As you can see here, the value of the put spread increases as the stock price falls, which is not good for a short put spread trader.

At expiration, both put strikes are in-the-money, which results in the maximum loss of $945 for the short put spread trader: ($5.55 sale price – $15 expiration price) x 100 = -$945 . Since a short put expires to +100 shares and a long put expires to -100 shares, no stock position is taken if the trader holds the in-the-money spread through expiration. However, it’s possible that the short put spread trader gets assigned on the short 110 put when it’s in-the-money with little extrinsic value.

Next, we’ll look at an example of a trade where the stock price is below the short put at expiration, but the position is still profitable.

Enjoying this analysis? Be sure to grab a copy of our free Trade Research PDF featuring historical trade results of the bull put spread on the S&P 500:

Trade Example #2: Partial Profit

In the next example, we’ll look at a situation where a trader sells an at-the-money put spread and does not realize the maximum profit potential.

Here’s the setup:

Initial Stock Price: $219.28

Strikes and Expiration: Short 220 put expiring in 49 days. Long 190 put expiring in 49 days.

Net Credit Received: $14.60 received for the 220 put – $4.60 paid for the 190 put = $10.

Breakeven Stock Price: $220 short put strike – $10 net credit received = $210.

Maximum Profit Potential: $10 net credit received x 100 = $1,000.

Maximum Loss Potential: ($30-wide put strikes – $10 credit received) x 100 = $2,000.

Let’s take a look:

As demonstrated here, the timing of the short put spread entry couldn’t have been worse. With just over 35 days to expiration, the put spread was trading for $20, which represents a $1,000 loss for a trader who sold the spread for $10.

However, since a short put spread has limited loss potential, let’s say the trader in this example held on to the position. Near expiration, the stock price rallied above the short put spread’s breakeven price of $210 and the put spread’s value fell. At expiration, the stock was trading for $217.11, which means the short 220 put was worth $2.89 and the 190 put was worthless. Since the trader sold the spread for $10, the expiration profit on the spread was $711: ($10 sale price – $2.89 expiration price) x 100 = +$711 .

Alright, you’ve seen short put spread examples that break even and realize the maximum loss. In the final example, we’ll investigate a trade that winds up with its greatest profit potential.

Trade Example #3: Maximum Profit Put Spread

In the final example, we’ll examine a bull put spread example that ends up with its maximum profit potential.

Here are the specifics of the final example:

Initial Stock Price: $716.03

Strikes and Expiration: Short 700 put expiring in 67 days. Long 640 put expiring in 67 days.

Net Credit Received: $30.20 received for the 700 put – $12.15 paid for the 640 put = $18.05.

Breakeven Stock Price: $700 short put strike – $18.05 net credit received = $681.95.

Maximum Profit Potential: $18.05 net credit received x 100 = $1,805.

Maximum Loss Potential: $60-wide put strikes – 18.05 net credit received = $4,195.

When the stock price rises significantly, the value of the put spread falls, which is great news for the put spread seller. In this example, there were plenty of opportunities for the trader to take profits before expiration. To close a bull put spread, the trader can simultaneously buy back the short put and sell the long put. As an example, let’s say the trader wanted to take profits when the spread’s price fell to $10. When the trader buys back the spread for $10, they lock in $805 in profits: ($18.05 initial spread sale price – $10.00 closing price) x 100 = +$805 .

At expiration, the stock is trading for over $725, and both the 700 and 640 put expire worthless. The resulting gain on the short 700 put is $3,020 and the loss on the long 640 put is $1,205. Therefore, the net profit on the position is $1,805 for the put spread seller, which is the position’s maximum profit potential.

Congratulations! You now know how short put spreads work as a trading strategy.

If you have any questions, comments, or feedback related to this post, feel free to contact me at any time.

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Bull Put Spread

What Is a Bull Put Spread?

A bull put spread is an options strategy that is used when the investor expects a moderate rise in the price of the underlying asset. The strategy uses two put options to form a range consisting of a high strike price and a low strike price. The investor receives a net credit from the difference between the two premiums from the options.

The Bull Put Spread Explained

Put options are typically employed by investors to profit from declines in a stock’s price since a put option gives an investor the power—not the requirement—to sell a stock at the expiration date of the contract. Each put option has a strike price, which is the price at which the option converts to the underlying stock at expiry. An investor would pay a premium to purchase a put option.

Key Takeaways

  • A bull put spread is an options strategy that is used when the investor expects a moderate rise in the price of the underlying asset.
  • The strategy pays a credit initially and uses two put options to form a range consisting of a high strike price and a low strike price.
  • The maximum loss is equal to the difference between the strike prices and the net credit received.
  • The maximum profit, which is the net credit only occurs if the stock’s price closes above the higher strike price at expiry.

Profits and Loss from Put Options

Put options are typically used by investors who are bearish on a stock, meaning they hope the stock’s price declines below the option’s strike. However, the bull put spread is designed to benefit if the stock’s price rises. If the stock is trading above the strike at expiry, the option expires worthless since no one would sell the stock at a strike price that’s lower than the market price. As a result, the buyer of the put loses the value of the premium paid.

On the other hand, an investor who sells a put option is hoping the stock doesn’t decrease but instead, rises above the strike so that the put option becomes worthless at expiry. A put option seller—the option writer—receives the premium for selling the option initially and wants to keep that sum. However, if the stock declines below the strike, the seller is on the hook. The option holder has a profit and will exercise their rights, selling their shares at the higher strike price. In other words, the put option is exercised against the seller.

The premium received by the seller would be reduced depending on how far the stock price falls below the put option’s strike. The bull put spread is designed to allow the seller to keep the premium earned from selling the put option even if the stock’s price declines.

Construction of Bull Put Spread

A bull put spread consists of two put options. First, an investor buys a put option and pays a premium. Next, the investor sells a put option at a higher strike price than the purchased put receiving a premium. Both options have the same expiration date.

The premium earned from selling the higher-strike put exceeds the price paid for the lower-strike put. The investor receives an account credit of the net difference of the premiums from the two put options at the onset of the trade. Investors who are bullish on an underlying stock could use a bull put spread to generate income with limited downside. However, there is a risk of loss with this strategy.

Bull Put Profit and Loss

The maximum profit for a bull put spread is equal to the difference between the amount received from the sold put and the amount paid for the purchased put. In other words, the net credit received initially is the maximum profit, which only happens if the stock’s price closes above the higher strike price at expiry.

The goal of the bull put spread strategy is realized when the price of the underlying moves or stays above the higher strike price. The result is the sold option expires worthless. The reason it expires worthless is that no one would want to exercise it and sell their shares at the strike price if it’s lower than the market price.

A drawback to the strategy is that it limits the profit earned if the stock rises well above the upper strike price of the sold put option. The investor would pocket the initial credit but miss out on any future gains.

If the stock is below the upper strike in the strategy, the investor will begin to lose money since the put option will likely be exercised. Someone in the market would want to sell their shares at this, more attractive, strike price.

However, the investor received a net credit for the strategy at the outset. This credit provides some cushion for the losses. Once the stock declines far enough to wipe out the credit received, the investor begins losing money on the trade.

If the stock price falls below the lower strike put option—the purchased put—both put options would have lost money, and maximum loss for the strategy is realized. The maximum loss is equal to the difference between the strike prices and the net credit received.

What We Like

Investors can earn income from the net credit paid at the onset of the strategy.

The maximum loss on the strategy is capped and known up-front.

The risk of loss, at its maximum, is the difference between the strike prices and the net credit paid.

The strategy has limited profit potential and misses out on future gains if the stock price rises above the upper strike price.

Real World Example of a Bull Put Spread

Let’s say an investor is bullish on Apple Inc. (APPL) over the next month. The stock is currently trading at $275 per share. The investor implements a bull put spread by:

  1. Selling one put option with a strike price of $280 for $8.50 to expire in one month
  2. Purchasing one put option with a strike price of $270 for $2 to expire in one month

The investor earns a net credit of $6.50 for the two options contracts ($8.50 credit – $2 premium paid). Since one options contract equates to 100 shares of the underlying asset the total credit equals $650.

Scenario 1 Maximum Profit

Let’s say the Apple’s stock rises and is trading at $300 at expiry. The investor’s maximum profit is achieved and equals $650 ($8.50 – $2 = $6.50 x 100 shares = $650). Once the stock rises above the upper strike price, the strategy ceases to earn any additional profit.

Scenario 2 Maximum Loss

If Apple’s stock is trading at $200 per share or below the low strike, the investor’s maximum loss is realized. However, the loss is capped at $350, or ($280 put – $270 put – ($8.50 – $2)) x 100 shares.

Ideally, the investor is looking for the stock to close above $280 per share on the expiration, which would be the point the maximum profit is achieved.

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