A Bear Put Spread is a directional strategy and is used when bearishness is expected in the stock/index chosen. At the same time the trader is sure that although bearishness is expected, the stock/index might find support at certain point in future.
To take advantage of this situation, the trader buys one in the money put and sells one out of the money put. Expiry of both the strikes and the underlying stock/index will be same.
On Oct 25 2017, Pidilite was trading at 800 rupees. I’m sure that this stock was going to go down in the coming month. At the same time 760 is the strongest support that the stock might take.
In this situation, I will buy 820 PE of Nov Expiry and sell 760 PE of Nov Expiry. Here since I’m purchasing an in-the-money put, premium would be higher. To reduce my cost of purchasing, I am selling a put option and will receive premium from the buyer.
On October 25 2017, 820PE was trading at 25 rupees roughly and 760PE was trading at 11.
So my total cost here would be 25-11=14 rupees.
If by expiry Pidilite reaches 760, I will receive profits from 820PE. Since I also sold 760PE and the underlying didn’t cross the strike price, I will retain the premium received from the buyer.
Let’s see the payoff diagram now
|Pidilite at Expiry (S)||Payoff from 820PE||Payoff from 760PE||Net Payoff|
As seen above, the profit and losses are capped in this strategy.