Bear Put Spread

The bear put spread is similar to the bull call spread, but is betting on a move down rather than a move up.

The bear put can also be compared to a long put but with some of the risk removed as well as a cap being placed on potential profits.

The trade is initiated when you buy one put at one strike price and simultaneously sell one put at a lower strike price. Both puts would have the same expiration date.

This produces a net debit position (you pay more for the long put at the higher strike price than you receive in premium from the short put at the lower strike price).

And since the premium received from the sale of the short put reduces the amount paid for the long put, the maximum loss is limited to this net debit amount. That would occur if the stock price closed at expiration at or above the strike price of the long put.

For this added protection, the maximum gain is reduced to the difference between the two strike prices less the original net debit paid.

Confused? Let's look at an example:

Bear Put Spread Example

EXAMPLE: The XYZ Zipper Company is trading around $40/share. You believe the stock will be under pressure in the near term, although you don't expect a total collapse in the share price.

You simultaneously purchase a $40 put and sell, or write, a $35 put. Both options expire in one month. You purchase the $40 put for $1.50/contract and sell, or write, the $35 put for $0.50/contract. The trade costs $100 to set up (the $150 debit less the $50 credit).

• If the stock finishes at $40 or higher, both puts expire worthless and you lose the entire $100 you had at risk.
• If the stock finishes at $39/share, you break even since the long put is $1 in the money (matching your initial investment) and the short put expires worthless.
• If the stock finishes at or below $35/share, the value of the position reaches its maximum level, $500 in this case. If the stock closes anywhere below $35/share, those additonal gains in the $40 put are offset by the increased value of the $35 short put. So the maximum gain is the $500 net value of the trade less the initial $100 it cost to set up, or $400.