The bear put spread strategy, commonly known as "Bull Put Spread," is a strategy suitable for investors anticipating a neutral or slightly bullish market. It involves simultaneously selling out-of-the-money put options with a higher strike price (short position) and buying in-the-money put options with a lower strike price (long position).
Strategy Principles:
Sell out-of-the-money put options with a higher strike price (short position):Investors sell put options with a higher strike price, collecting the premium, and anticipating that the asset's price will not fall to that strike price.
Buy in-the-money put options with a lower strike price (long position):Simultaneously, to limit potential downside risk, investors buy put options with a lower strike price, paying a premium.
Profit and Loss Characteristics:
Maximum Profit:Achieved when the asset's price at expiration is above the higher strike price, with profits equal to the premium received.
Maximum Loss:Incurred when the asset's price at expiration is below the lower strike price, with losses equal to the difference between the two strike prices minus the net premium received.
Breakeven Point:The higher strike price minus the net premium received.
Real-world Example:
Assume the current stock price of Z is $100, and the investor has a neutral outlook for the short term. The investor performs the following actions:
Sells an out-of-the-money put option with a $100 strike price, receiving a premium of $4.
Buys an in-the-money put option with a $90 strike price, paying a premium of $1.
Therefore, the net premium received is $3 ($4 - $1).If the stock price of Z is above $100 at expiration, both options expire worthless, resulting in a profit of the net premium received, i.e., $3.
If the stock price of Z falls to $85 at expiration, the sold put option incurs a loss of $15, while the bought put option gains $5. The total loss is $10, resulting in a net loss of $7 ($10 - $3).
Profit and Loss Chart:
To visually represent the profit and loss situation of the bull put spread strategy, we will create a chart. The horizontal axis represents the stock's expiration price, and the vertical axis represents the strategy's profit and loss. The chart will illustrate the variations in profit and loss at different stock price levels.
Next, I will create this profit and loss chart.
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