Bull Put Spread

Bull put spreads, also known as short put spreads, are credit spreads that consist of selling a put option and purchasing a put option at a lower price. The strategy looks to take advantage of an increase in price in the underlying asset before expiration. Time decay and decreased implied volatility will also benefit the bull put credit spread.

Bull Put Credit Spread market outlook

A bull put credit spread is entered when the seller believes the price of the underlying asset will be above the short put option’s strike price on or before the expiration date. Bull put spreads are also known as put credit spreads because they collect a credit when the trade is entered. The risk is limited to the width of the spread minus the credit received. The break-even price for the bull put credit spread is the short strike price minus the net credit received. Time decay and decreased implied volatility will also help the position become profitable. The closer the short strike price is to the underlying’s price, the more credit will be received at trade entry.

How to set up a Bull Put Credit Spread

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

Bull Put Credit Spread payoff diagram

The bull put credit spread payoff diagram clearly outlines the defined risk and reward of credit spreads. Bull put spreads collect a credit when entered. The credit received is the maximum potential profit for the trade. Because long options are purchased for protection, the maximum risk is limited to the width of the spread minus the credit received.

For example, if a $5 wide bull put spread collects $1.00 of credit, the maximum gain is $100 if the stock price is above the short put at expiration. The maximum loss is $400 if the stock price is below the long put at expiration. The break-even point would be the short put strike minus the premium received.

Entering a Bull Put Credit Spread

A bull put spread consists of selling-to-open (STO) a put option and buying-to-open (BTO) a put option at a lower strike price, with the same expiration date. This will result in a credit received. Buying the lower put option will reduce the overall premium collected to enter the trade but will define the position's risk to the width of the spread minus the credit received.

For example, if an investor believes a stock will be above $50 at expiration, they could sell a $50 put option and buy a $45 put option. If this results in a $1.00 credit, the maximum profit potential is $100 if the stock closes above $50 at expiration, and the maximum loss is $400 if the stock closes below $45 at expiration.

• Sell-to-open: $50 put
• Buy-to-open: $45 put

The closer to the underlying stock price the spread is sold, the more bullish the bias.

Exiting a Bull Put Credit Spread

A bull put credit spread is exited by buying-to-close (BTC) the short put option and selling-to-close (STC) the long put option. If the spread is purchased for less than it was sold, a profit will be realized. If the stock price is above the short put option at expiration, both options will expire worthless, and the entire credit will be realized as profit. If the stock price is below the long put option at expiration, the two contracts will offset, and the position will be closed for the maximum loss.

For example, if a bull put credit spread is opened with a $50 short put and a $45 long put, and the underlying stock price is below $45 at expiration, the broker will automatically buy shares at $50 and sell shares at $45. If the stock price is between the two put options at expiration, the short option will be in-the-money and need to be repurchased to avoid assignment.

Time decay impact on a Bull Put Credit Spread

Time decay, or theta, works in the advantage of the bull put credit spread strategy. Every day the time value of an options contract decreases. Theta will exponentially lose value as the options approach expiration. The decline in value may allow the investor to purchase the options for less money than initially sold, even if a significant rise in price does not occur.

Implied volatility impact on a Bull Put Credit Spread

Bull put credit spreads benefit from a decrease in the value of implied volatility. Lower implied volatility results in lower option premium prices. Ideally, when a bull put credit spread is initiated, implied volatility is higher 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.

Adjusting a Bull Put Credit Spread

Bull put spreads can be adjusted if the underlying stock price has moved down and the position is challenged. An investor has two choices to maximize the probability of success as the position approaches expiration. 

If the stock price has decreased, an opposing bear call credit spread can be opened above the put spread to create an iron condor. Additional credit will be received and no additional risk will be added to the position if the spread width and number of contracts remain the same.

For example, if a $55 / $60 call credit spread is added to the original position and collects $1.00 of premium, the break-even point will be extended down and give the position a higher probability of profit while reducing risk. However, if the stock reverses, the bear call spread could become challenged.

• Sell-to-open: $55 call
• Buy-to-open: $60 call
  

If the stock price has decreased substantially and the short option is in-the-money, an opposing bear call credit spread may be opened with the same strike price and expiration date as the put spread. This will create an iron butterfly. Additional credit will be received and no additional risk will be added to the position if the spread width and number of contracts remain the same. A credit spread adjusted to an iron butterfly will have more profit potential and less risk than an iron condor, but the position’s range of profitability ($47 - $53) is smaller than an iron condor.

For example, if a call credit spread centered at the same $50 strike price collects an additional $2.00 of credit, the break-even point will be extended down and give the position a higher probability of profit while reducing risk. However, if the stock reverses, the bear call spread could become challenged.

• Sell-to-open: $50 call
• Buy-to-open: $55 call

Rolling a Bull Put Credit Spread

Bull put spreads can be rolled out to a later expiration date to extend the duration of the trade. Rolling the position for a credit reduces risk and extends the break-even point. To roll the position, purchase the existing bull put credit spread and sell a new spread with a later expiration date. 

For example, if the original bull put spread has a June expiration date and received $1.00 of premium, an investor could buy-to-close (BTC) the entire spread and sell-to-open (STO) a new position with the same strikes in July. If this results in a $1.00 credit, the maximum profit potential increases by $100 per contract and the maximum loss decreases by $100 per contract. The new break-even price will be $48.

Hedging a Bull Put Credit Spread

Bull put credit spreads can be hedged to help minimize the position’s risk while increasing profit potential. If the stock price has moved down, an opposing bear call credit spread can be opened with the same spread width and expiration date as the bull put spread. This brings in additional credit while reducing the maximum risk. The new spread helps to offset the loss of the original position.