Bear Put Spread
Underlying Strategy
(Moderately Bearish)(Bearish with a downside target)
When a trader is moderately bearish on the instrument and has a specific target for the price.
Methodology
The trader buys a PE of a strike price at which she believes the stock shall close below at the time of expiry and sells a PE of a lower strike price at which she expects the price to hit a support level.
The ideology behind selling the put of a lower strike price is that the net premium paid is reduced substantially and hence net loss is limited.The net premium paid shall be the cost of Long PE – Cost of Short PE.
However, this strategy gives a limited maximum profit, even if the stock goes outright bearish.
Risk Profile:
This is a low-risk low-profit setup as the loss is limited but the max profit is also capped.The strategy has a pretty good risk-reward ratio in moderately bearish markets.
Margin requirements are high as you are selling a PE.
Calculations:
Max Potential Profit: (Long PE Strike-Short PE Strike)-Net premium paid
When: The stock crosses the lower strike price at the time of expiry.
Max Potential Loss: Net premium paid
When: The stock is above the higher strike price at the time of expiry.
Price of Breakeven at expiration: Long CE strike-Net premium paid
Impact with passage of time
The Long PE price has a negative time value while the short PE has a positive time value.
However, the short PE will have a slower time decay than the Long PE.
Hence the net effect of time decay is slightly negative.
Illustration
For example, the trader is moderately bearish on Grasim. He believes that the stock would only make a small correction in the near term.
In order to catch the small fall in the price of the stock, he can buy a naked Put Option in Grasim , or buy an OTM PE and sell an OTM PE of a lower strike price.
This is the best strategy for a moderately bullish view on a stock.
The reason for selling the OTM PE is that we get a net premium by selling and hence the net premium paid for the whole strategy reduces a whole.
In this case his risk is considerably reduced, but his profit potential is also limited.
This strategy is the best for risk averse traders but requires a higher margin as the trader is shorting an option.
GRASIM is currently trading at 1190. The trader decides to buy 1 lot PE of strike price 1160 of near month expiry, paying a premium of Rs. 16.45 per share., and then sells 1 lot CE of strike price 1120 per share receiving a premium of 10.7.
The net premium paid is then (16.45-10.7=5.75)*LotSize=5.75*750=Rs.4312.
This net premium paid is the maximum loss which the trader can incurr using this strategy.
Let us consider the black line viz. 1160 PE as Option A and the green line viz.
1120 PE as Option B.
Orange Line is the total profit for the strategy.
Option A turns profitable after Strike Price A-Premium (1160-16.45=1143.45) and Option B turns into a loss after (1120-10.7=1109).
At the time of expiry, if the stock price is above 1143, then the trader shall incurr a loss of the net premium paid, while if the stock price is below 1109, then the strategy shall see a fixed profit of Rs,. 25687
Now let us consider different scenarios for the strategy
Stock closes at Rs.1100.
Value of Option A=60
Value of Option B=20
Net profit in Option A= ( Value-Premium)*LotSize
=(60-16.45)*750
=Rs.32662
Net profit in Option B=(Premium-Value)*Lotsize
=(10.7-20)*750
=-Rs. 6975 Loss
Net Profit= 32662-6975=Rs.25687
Stock closes at Rs.1125.
Value of Option A= 35
Value of Option B=0
Net profit in Option A= ( Value-Premium)*LotSize
=(35-16.45)*750
=Rs.13912
Net profit in Option B=(Premium-Value)*Lotsize
=(10.7)*750
=Rs. 8025 Profit
Net Profit= 13912+8025=Rs.21937
Stock closes at 1150
Value of Option A= 10
Value of Option B=0
Net profit in Option A= ( Value-Premium)*LotSize
=(10-16.45)*750
=-Rs.13912
Net profit in Option B=(Premium-Value)*Lotsize
=(10.7)*750
=Rs. 8025
Net Profit= -13912+8025=-5887
Stock closes at 1180
Value of Option A=0
Value of Option B=0
Net profit in Option A= ( Value-Premium)*LotSize
=(0-16.45)*750
=-12337
Net profit in Option B=(Premium-Value)*Lotsize
=(10.7-0)*750
=Rs. 8025
Net Profit= 18510+2310=-Rs.4312
Stock closes at 1200
Value of Option A=0
Value of Option B=0
Net profit in Option A= ( Value-Premium)*LotSize
=(0-16.45)*750
=-12337
Net profit in Option B=(Premium-Value)*Lotsize
=(10.7-0)*750
=Rs. 8025
Net Profit= 18510+2310=-Rs.4312
| Value of Spot at expiry | Long Put Strike Price | Net premium paid for A | Intrinsic Value of Option A | P/L for Long Put | Short Put Strike Price | Net premium received for B | Intrinsic Value of Option B | P/L for Short Put | Net P/L |
| 1060 | 1160 | 16.45 | 100 | 83.55 | 1120 | 10.7 | 60 | -49.3 | 34.25 |
| 1070 | 1160 | 16.45 | 90 | 73.55 | 1120 | 10.7 | 50 | -39.3 | 34.25 |
| 1080 | 1160 | 16.45 | 80 | 63.55 | 1120 | 10.7 | 40 | -29.3 | 34.25 |
| 1090 | 1160 | 16.45 | 70 | 53.55 | 1120 | 10.7 | 30 | -19.3 | 34.25 |
| 1100 | 1160 | 16.45 | 60 | 43.55 | 1120 | 10.7 | 20 | -9.3 | 34.25 |
| 1110 | 1160 | 16.45 | 50 | 33.55 | 1120 | 10.7 | 10 | 0.7 | 34.25 |
| 1120 | 1160 | 16.45 | 40 | 23.55 | 1120 | 10.7 | 0 | 10.7 | 34.25 |
| 1130 | 1160 | 16.45 | 30 | 13.55 | 1120 | 10.7 | 0 | 10.7 | 24.25 |
| 1140 | 1160 | 16.45 | 20 | 3.55 | 1120 | 10.7 | 0 | 10.7 | 14.25 |
| 1150 | 1160 | 16.45 | 10 | -6.45 | 1120 | 10.7 | 0 | 10.7 | 4.25 |
| 1160 | 1160 | 16.45 | 0 | -16.45 | 1120 | 10.7 | 0 | 10.7 | -5.75 |
| 1170 | 1160 | 16.45 | 0 | -16.45 | 1120 | 10.7 | 0 | 10.7 | -5.75 |
| 1180 | 1160 | 16.45 | 0 | -16.45 | 1120 | 10.7 | 0 | 10.7 | -5.75 |
| 1190 | 1160 | 16.45 | 0 | -16.45 | 1120 | 10.7 | 0 | 10.7 | -5.75 |
| 1200 | 1160 | 16.45 | 0 | -16.45 | 1120 | 10.7 | 0 | 10.7 | -5.75 |
| 1210 | 1160 | 16.45 | 0 | -16.45 | 1120 | 10.7 | 0 | 10.7 | -5.75 |
| 1220 | 1160 | 16.45 | 0 | -16.45 | 1120 | 10.7 | 0 | 10.7 | -5.75 |
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