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Table of Contents
A bear put spread, also known as a debit put spread, involves buying a put at a higher strike price and selling another at a lower strike price, both tied to the same expiration date and underlying asset.
Essentially, a long put is purchased with the goal of profiting from a decline in the underlying asset’s price, while a short put is purchased to reduce the cost of the strategy, and limit potential losses. The level of risk is well-defined, with the maximum loss limited to the net premium paid upfront, but the potential gains are limited as well.
A bear put spread is a type of vertical spread that a trader might typically consider when they’re moderately bearish on an asset.
Key Points
• Bear put spreads involve buying a put at a higher strike price and selling a put on the same asset at a lower strike price, both with the same expiration date.
• Potential profits depend on the underlying asset’s price declining below the lower strike price by expiration.
• Maximum loss is limited to the net premium paid for the spread.
• The break-even point is reached when the stock price is below the higher strike price by the amount of the net premium paid.
• Time decay affects the spread’s value differently depending on the asset price relative to the strike prices.
Bear Put Spread Definition
A bear put spread is an options strategy in which a trader buys a high strike put and sells a low strike put. Like other options strategies, bear put spreads may be traded at different types of moneyness, including out-of-the-money (OTM), at-the-money (ATM), or in-the-money (ITM). This strategy is typically used by traders who are bearish on a stock, have a downside price target, and have a defined time horizon.
The maximum profit occurs when the underlying asset is at or below the lower strike by expiration.
The trader will incur a debit (cost) equal to the price of the purchased put option minus the price of the sold put option when initiating the trade. An investor may lose the entirety of the debit if the underlying stock closes at or above the strike price of the long put (the higher strike price) at expiration.
The closer the strike prices are to the price of the underlying asset, the higher the debit incurred. Paying a larger debit may reduce the maximum potential profit, since the profit ceiling defined by the strike spread remains fixed.
How Does a Bear Put Spread Work?
There are two basic types of options: puts and calls. Options are a type of derivative that allows investors to seek profits from the potential price of movements of assets, without having to own those assets outright. A bear put spread is one of many strategies for options trading.
With a bear put spread, the investor may profit if the underlying stock price declines below the long put’s strike price by expiration. It is not as bearish as buying puts outright because the short put both reduces the upfront cost and caps the maximum gain. It may also come with lower defined risk than selling a put.
In options terminology, maximum gains are reached when the underlying asset trades at or below the lower strike price at expiration. A bear put spread is cheaper to enter since the sale of the lower strike put helps finance the trade.
Losses are limited to the net debit (cost) incurred when the trade is entered. However, early assignment of the short put may occur before expiration, which could result in unexpected exposure. Those losses may be incurred if the underlying asset price closes above the strike price of the long put (higher strike price) at expiration.
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Maximum Profit
A bear put spread’s maximum profit is:
Difference between strike prices – Net premium (debit) paid
Maximum Loss
A bear put spread’s maximum loss is:
Net premium paid, plus any commissions
Breakeven
The breakeven point for a bear put spread is:
Strike price of the long put (higher strike) – Net premium paid
Bear Put Spread Example
Assume that shares of XYZ stock are currently trading at $100. A trader anticipates that the shares will decrease to $95 by the following month’s option expiration date. To enter into a bear put spread, a trader could purchase a $100 put for $4.00 while simultaneously selling a $95 put for $2.00. The sale of the low strike option helps to make a bearish position less expensive since the trader collects that premium while paying for the high strike put option.
The maximum loss and net debit for this bear put spread is:
Premium paid = Cost of Long Put – Cost for Short Put
Premium paid = $4.00 – $2.00 = $2.00 net debit
Note: The $2.00 net debit is per share. Since an option contract is for 100 shares, the debit will be $200 per option contract.
The maximum profit for this bear put spread is:
Maximum profit = Width of strike prices – Premium paid
Maximum profit = $100 – $95 – $2.00 = $3.00 per share or $300 per option contract
The breakeven point for this trade is when the stock price reaches:
Breakeven = Strike price of long put – Premium paid
Breakeven = $100 – $2.00 = $98.00
Bear Put Spread Graph: Payoff Diagram
This profit and loss diagram helps illustrate the payoff in the above example of a bear put spread. Again, assuming that a $100 strike put is bought at $4 and a $95 strike put is sold at $2, the breakeven in this example is $98 — the $100 strike minus the $2 premium paid. Understanding the Greeks in options trading can also shed light on how this strategy responds to time, price, and volatility.
Recommended: How Are Options Priced?
Impact of Price Changes
As the price of the underlying asset falls, the bear put spread tends to increase in value. As the asset price rises, the bear put spread’s value falls. The position is said to have a negative Delta since it typically profits when the underlying stock price falls.
Due to the dual-option structure of this trade, the rate of change in delta, known as Gamma, is minimal as the underlying asset price changes.
Impact of Volatility
The impact of volatility is minimized due to the dual option structure of the trade. Vega, in the option Greeks, measures an option’s sensitivity to changes in volatility. Between the short put and long put, the trade has a near-zero Vega.
However, asset price changes can result in volatility affecting the price of one put more than the other.
Impact of Time
The impact of time decay, also known as Theta, varies based on the asset price relative to the strike prices of the two options.
When the asset price is above the long put strike price, the value of the bear put spread decreases as time passes. This is because the long put loses value more rapidly than the short put.
When the asset price is below the short put strike price, the value of the bear put spread increases as time passes as the short put decays faster than the long put.
When the asset price is between the strike prices, the effect of Theta is minimal because both options tend to lose value at a similar rate.
Closing Bear Put Spreads
Traders may choose to close out a bear put spread before it expires, if it is profitable. If it has reached its maximum possible profit, the position may be closed out to capture the realized gain.
Another reason to close a bear put spread position as soon as the maximum profit is reached is due to the risk of early assignment on the short put, which could result in a long stock position. If assigned early, the trader could be left with a long stock position and may be forced to hold the stock, exposing them to further losses beyond the initial premium. To avoid this situation, traders either close the full bear put spread or exit the short leg separately by buying it back, while leaving the long put open.
If the short put is exercised and the long stock position is created, the trader can close out the position by selling the stock in the market to close out the long position, exercising the long put. Each of these options may incur additional transaction fees that could reduce the trade’s net return, hence the potential benefit of closing out a maximum profit position as soon as possible.
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Pros and Cons of Bear Put Spreads
| Pros | Cons |
|---|---|
| Has defined risk compared to shorting a stock | The short put may be assigned, resulting in a long stock position |
| May be beneficial if the stock experiences a gradual decline in the stock price | Maximum loss is equal to the net debit paid |
| Maximum loss is limited to the net debit | Profits are capped at or below the short put’s strike price, which is the lower strike price in the spread |
Bear Put Spread vs Bear Call Spread
A bear put spread differs from a bear call spread — also known as a short call spread — in that the latter uses call options instead of put options. A bear call spread features a short call at a low strike and a long call at a higher strike. This strategy has a slightly different payoff profile compared to a bear put spread.
A bear call spread opens at a net credit, meaning proceeds from the sale of the low strike call are larger than the payment for the purchase of the long call at a higher strike. The maximum profit is limited to the net credit received when opening the trade.
The maximum loss on a bear call spread is limited to the difference between the low strike option and the high strike option, minus the net credit received. The stock price is usually below the low strike when the trade is established.
The primary difference is that a bear call spread doesn’t require the underlying stock to decline to turn a profit. A flat stock price by expiration allows traders to simply keep their net credit. In contrast, a bear put spread is done at a net debit, so the stock must fall to make money with a bear put spread.
| Bear Put Spread | Bear Call Spread |
|---|---|
| Buying a high strike put and selling a low strike put | Buying a high strike call and selling a low strike call |
| Done at a net debit | Done at a net credit |
| Underlying stock price must drop to make a profit | Underlying stock can be neutral and still make a profit |
| Max loss is the premium paid | Max gain is the premium received |
When to Consider a Bear Put Spread Strategy
Traders may want to consider constructing a bear put spread when they are moderately bearish on a stock and have a specific price target.
For example, if a trader expects XYZ stock will dip from $100 to $90, a bear put spread might be suitable. The trader might buy the $105 put and sell the $90 put at a net debit.
If the stock indeed falls to $90 by the expiration date, the shareholder keeps the premium from the low strike short put and profits from a higher value on the high strike long put.
Traders may want to have a timeframe in mind for puts, as they will have to choose their option’s expiration date.
Finally, a bear put spread should be considered when a trader has a bearish near-term outlook on a stock and seeks to keep their capital outlay small.
The Takeaway
Bear put spreads are used to place bearish bets on a stock. They offer limited risk and reduced cost compared to buying puts, and the potential for profit if the stock declines moderately. Bear put spreads allow options traders to express a bearish outlook on a stock while managing costs and defining maximum potential losses. This may be a cost-effective strategy for profiting from moderate price declines, though adverse price movements could result in losses.
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FAQ
What is a bearish options strategy?
A bearish options strategy is an option trade used when an investor anticipates that the underlying asset price will decline. If an investor is bullish, they expect the asset’s price to rise.
What is the maximum profit for a bear put spread?
The maximum profit for a bear put spread is the difference between the strike prices minus the net premium paid.
Maximum profit = long put strike price – short put strike price – net premium paid
What does it take for a bear put spread to break even?
A bear put spread strategy breaks even at expiration when the stock price is below the high strike by the amount of the net premium paid at the trade’s initiation.
Breakeven = long put strike price – net premium paid
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