Disposition: Bearish
How it Works
A bear put spread is a type of options strategy where an investor expects a moderate-to-large decline in the price of a security and wants to reduce the cost of holding the option trade. A bear put spread is achieved by purchasing put options while also selling the same number of puts on the same asset with the same expiration date at a lower strike price. The maximum profit using this strategy is equal to the difference between the two strike prices minus the net cost of the trade.
Example:
Let’s say TSLA is trading at 680. We can use a bear put spread by purchasing one put option contract with a strike price of $675 for a cost of $5 and selling one put option contract with a strike price of $665 for a credit of $2. The cost of the strategy is debit paid for bought puts - credit for sold puts = $3
BTO 1 TSLA 15JUL MTHLY 675.00 PUTS Debit 5
STO 1 TSLA 15JUL MTHLY 665.00 PUTS Credit 2
BTO: Buy to Open
STO: Sell to Open
Max Profit and Max Loss
Max Profit = $7 ($10 difference in strike prices - $3 cost of trade)
Max Loss = $3
FAQ
Scenario 1: What happens if trade closes the above-purchased Strike?
If it closes above the higher strike price of $675 there will be a loss of the entire amount spent to buy the spread.
Scenario 2: What happens if trade closes between strikes at expiration?
If it closes between the two strike prices, there will be a reduced profit. To avoid complexity, closing the position prior to expiration could be a good option. Speak to your broker for more information.
Scenario 3: What happens if, as the price of the security goes down, I am assigned sold puts?
With the example above, the profit from the bear put spread maxes out if the underlying security closes at or under $665, the lower strike price, at expiration. If it closes below $665 there will not be any additional profit. If you are assigned, long puts will offset assignment.
Risk Management & Strategy
Position size: 3 - 5% of your total account value
Be ok with not being able to take every trade that does not make sense money-wise in relation to your account size
If buying more than 1 contract, selling a portion as price falls is a great way to reduce risk and let the trade run without taking a significant loss if the trade goes against you.
Have a predetermined set amount you are willing to lose and gain (OCO order is a great way to take emotion out of trading)
Pro tip: knowing where there could be support and resistance will help set realistic profit and loss goals
Purchasing shorter-term call contracts with a Trail Stop, if there is a concern of short-term bull run, could help offset loss if stopped out (Hedging)