Bear Put Debit Spread

Bear put spreads are debit spreads that consist of buying a put option and selling a put option at a lower price. The strategy looks to take advantage of a decline in price from the underlying asset before expiration. Increased implied volatility will also benefit the bear put debit spread.

A bear put debit spread is entered when the buyer believes the price of the underlying asset will decline before the expiration date. Bear put spreads are also known as put debit spreads because they require paying a debit when the trade is entered. The risk is limited to the debit paid at entry. The maximum profit potential is the width of the spread minus the debit paid. To break even on the position, the stock price must be below the long put option by at least the cost to enter the position. The further out-of-the-money the bear put debit spread is initiated, the more aggressive the outlook.

A bear put debit spread is made up of a long put option with a short put option sold at a lower strike price. The debit paid is the maximum risk for the trade. The maximum potential profit is the width of the spread minus the premium paid. The closer the strike prices are to the underlying’s price, the more debit will be paid, but the probability is higher that the option will finish in-the-money. The larger the width of the spread is between the long option and the short option, the more premium will be paid, but the maximum potential profit will be higher.

The bear put spread payoff diagram clearly outlines the defined risk and reward of debit spreads. Bear put spreads require a debit when entered. The debit paid is the maximum potential loss for the trade. Because a short option is sold to reduce the trade’s cost basis, the maximum profit potential is limited to the width of the spread minus the debit paid.

For example, if a $5 wide bear put debit spread costs $1.00, the maximum gain is $400 if the stock price is below the short put at expiration, and the maximum loss is $100 if the stock price is above the long put at expiration. The break-even point would be the long put strike minus the premium paid.

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A bear put spread consists of buying-to-open (BTO) a put option and selling-to-open (STO) a put option at a lower strike price, with the same expiration date. This will result in paying a debit. Selling the lower put option will help reduce the overall cost to enter the trade and define the risk, but will also limit the profit potential.

For example, if an investor believes a stock will be below $50 at expiration, they could buy a $50 put option and sell a $45 put option. If this costs $1.00, the maximum loss possible is $100 if the stock closes above $50 at expiration, and the maximum profit potential is $400 if the stock closes below $45 at expiration. The break-even point would be $49.

Bear put debit spreads can be entered at any strike price relative to the underlying asset. In-the-money options will be more expensive than out-of-the-money options. The further out-of-the-money the spread is purchased, the more bearish the bias.

A bear put debit spread is exited by selling-to-close (STC) the long put option and buying-to-close (BTC) the short put option. If the spread is sold for more than it was purchased, a profit will be realized. If the stock price is below the short put option at expiration, the two contracts will offset, and the position will be closed for a full profit.

For example, if a bear put debit spread is opened with a $50 long put and a $45 short put, and the underlying stock price is below $45 at expiration, the broker will automatically sell shares at $50 and buy shares at $45. If the stock price is above the long put option at expiration, both options will expire worthless, and the full loss of the original debit paid will be realized.

Time decay, or theta, works against the bear put debit spread. Every day the time value of the long options contract decreases. Ideally, a large move down in the underlying stock price occurs quickly, and an investor can capitalize on all the remaining extrinsic time value by exiting the position.

Bear put debit spreads benefit from an increase in the value of implied volatility. Higher implied volatility results in higher options premium prices. Ideally, when a bear put debit spread is initiated, implied volatility is lower than it is at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Bear put debit spreads have a finite amount of time to be profitable and have multiple factors working against their success. If the underlying stock does not move far enough, fast enough, and/or volatility decreases, the bear put debit spread will lose value rapidly and result in a loss. Bear put spreads can be adjusted like most options strategies but will almost always come at more cost and, therefore, add a debit to the trade and extend the break-even points.

If time is running out before expiration, the full spread can be rolled out to a later expiration date. If the stock price moves up and away from the bear put spread, a bull call debit spread could be added at the same strike price and expiration as the bear put debit spread. This would create a long butterfly and allow the position to profit if the underlying price continues to increase. The additional debit spread will cost money and extend the break-even points.

Bear put debit spreads can be rolled out to a later expiration date if the underlying stock price has not moved enough. This is accomplished by selling the existing bear put spread and re-purchasing a new spread for a debit with the same or different strike prices at a later expiration date. This will cost money but will extend the duration of the trade.

Bear put debit spreads can be hedged if the underlying stock has moved up in price. To hedge the bear put spread, purchase a bull call debit spread at the same strike price and expiration as the bear put spread. This would create a long butterfly and allow the position to profit if the underlying price continues to rise. The additional debit spread will cost money and extend the break-even points.