What is a Bear Put Spread?
A bear put spread, also known as a long put spread or debit put spread, is a vertical spread which has to do with the buying of one put with the hope of profiting from the decline of an underlying stock, and writing (selling) another put at a lower strike to offset part of the cost. To use this strategy a net cash outlay or net debit is required at the outset.
Understanding Bear Put Spread
An investor or trader can achieve the bear put spread by buying put options and writing the same number of puts with the same expiry date at a lower strike price. The purpose of the bear put spread is to net a profit when there is a decrease in the price of an underlying security.
Assuming there’s a stock trading at $20. By using the bear put spread an options trader can buy one put option contract at a $25 strike price for a cost of $325 ($3.25 x 100 shares/contract) and writing (selling) another put option at a $20 strike price for a cost of $115 ($1.15 x 100 shares/contract). The options trader or investor would have to pay a total of $210 ($350- $115) to achieve his/her goal. Peradventure, the price of the underlying asset eventually drops below $20 by the expiration date, the options trader will make a profit of $290. To get the total of the profit difference in the strike prices is multiplied by 100 shares/contract minus the net price of the two contracts.
It is represented as thus:
$25-$20 = $5 (the difference in the strike prices)
$325 - $115 = $210
Calculation illustration: $5 x 100 - $210 = $290