Stratégies Options - Long Put Spread : A First Attempt

Long put spread is a simple strategy which combines the purchase and the sale of two options of the same type, puts, concerning the same underlying, having the same maturity, and with different strikes.

I - Situation

When we buy a put, we have a bearish view on the underlying. It means that we’re waiting for a decline on an asset.
A trader can have a bearish perspective on an asset, but a limited one. That is that he can very well anticipate a decline of the underlying asset, without this one is "infinite" or " indefinite". It is then useless and even expensive to buy one naked put.

II - How to use it

From the previous situation, on can perfectly imagine that an operator wishes to be a seller at the level K, until a certain level K ' below which he may give up the position. He wishes for example to sell a share to 100 euro but wishes to give up the decline below 80 euro, little convinced that the share will fall beyond.

To be a seller from a level K can be translated by the purchase of one put struck at K and being a buyer from a level K ' can be translated by the sale of a put struck at K '.
In the example above, the trader can buy one put spread 100/80 on that asset

III - Advantage

The major interest is that by buying one put and by selling the other one, the amount to be paid out is lower than naked put, and in the eventuality the underlying does not fall below the level K ', the gains are identical to those that would have be accomplished by the purchase of a naked put struck at K.

IV - Maximum gains are limited

The maximum gains are the difference between strikes, less net premiums.
If the 100 put was bought for $11 and the 80 put was sold for $5, the maximum gains are: 100 - 80 - ( 9.5 - 2.5 ) = 20 - 7 = $ +13 for each put spread.

V - Le risk

The risk of the put spread is limited to the net amount paid out for the purchase of the put with strike K - (less) the amount collected by the sale of the put with strike K ').

By taking back the example this above, the maximum risk is 9.5 - 2.5 = $ +7 . We can lose no more than $5 with this put spread (much less than $9.5 with the 100 put only!).

VI - Graphic Representation

This is a representation of a 1 year put spread 100/80 , having a 30 % implied volatility, and with an interest rate of 1 %. Neither dividend nor revenue.

Next : Long Call Spread : Delta
Previous : The Call Spread: A First Attempt

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BASIC OPTIONS STRATEGIES - INDEX
BASIC OPTIONS STRATEGIES - CHAPTER I
BASIC OPTIONS STRATEGIES - CHAPTER II
BASIC OPTIONS STRATEGIES - CHAPTER III
BASIC OPTIONS STRATEGIES - CHAPTER IV

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