What is a bear put spread (short answer)
– A bear put spread is an options strategy used when you expect a moderate decline in a security’s price. You buy a put option with a higher strike price and sell a put option on the same underlying asset with the same expiration but a lower strike. The net result is a debit (you pay to establish it), a limited maximum profit, and a known maximum loss equal to the net premium paid.
Key terms (defined on first use)
– Put option: a contract that gives its buyer the right (but not the obligation) to sell a fixed quantity of an asset at a specified price (the strike) before or at expiration.
– Strike price: the agreed price at which the asset can be sold (for a put).
– Expiration: the date the option contract ceases to exist.
– Net debit: the upfront cost to establish the spread = premium paid for long put − premium received for short put.
– Contract size: standard equity option contract usually represents 100 shares.
How it works (formulae)
– Net debit per contract = (Premium_paid_long_put − Premium_received_short_put).
– Maximum loss per contract = Net debit (expressed per share × contract size).
– Maximum profit per contract = [(Higher_strike − Lower_strike) × contract_size] − Net_debit.
– Break-even price at expiration = Higher_strike − (Net_debit per share).
Step‑by‑step: how to implement a bear put spread
1. Define market view: you expect a modest decline (not a crash).
2. Choose expiration date: pick a timeframe consistent with your thesis.
3. Select strikes: buy the higher (closer to current price) put and sell a lower strike put to offset premium.
4. Check liquidity and bid‑ask spreads for both options.
5. Calculate net debit, max profit, max loss, and break‑even.
6. Enter the trade (simultaneous order as a spread if possible to reduce execution risk).
7. Monitor and decide exit: close the spread, let expire, or exercise/assign if necessary (be mindful of early assignment risk on short puts).
8. Consider transaction costs and margin rules with your broker.
Checklist before placing the trade
– Confirm bearish but not extremely bearish outlook.
– Verify both options have the same expiration.
– Calculate:
– Net debit (per share and per contract),
– Max profit,
– Max loss,
– Break‑even price.
– Check option liquidity and implied volatility (higher IV increases premiums).
– Understand assignment risk on the short put (especially if it goes deep in the money or around corporate events).
– Factor in commissions and fees.
– Use position sizing consistent with risk management rules.
Pros and cons (practical)
Pros
– Lower upfront cost than buying a single put because selling the lower strike put offsets part of the premium.
– Known maximum loss limited to the net debit.
– Less risky than shorting the underlying stock (short stock has theoretically unlimited loss).
Cons
– Profit potential capped at the strike differential minus net debit.
– You lose the entire premium paid if the stock ends above the higher strike at expiration.
– Possibility of early assignment on the short put (you could be put the shares or required to take action).
– If the stock falls sharply, you forego additional profit beyond the capped maximum.
Worked numeric example (one standard option contract = 100 shares)
Assume the underlying stock is trading at $30 today.
– Buy 1 put, strike $35, premium = $4.75 → cost = $4.75 × 100 = $475.
– Sell 1 put, strike $30, premium = $1.75 → receive = $1.75 × 100 = $175.
Calculations:
– Net debit = $475 − $175 = $300 (or $3.00 per share).
– Maximum profit = [(35 − 30) × 100] − $300 = $500 − $300 = $200 (or $2.00 per share).
– Maximum loss = Net debit = $300 (or $3.00 per share).
– Break‑even price = Higher_strike − net_debit_per_share = 35 − 3 = $32.
Interpretation:
– If the stock finishes below $30 at expiration, you realize the maximum profit of $200.
– If it finishes between $30 and $35, you have a partial profit (or reduced loss), depending on final price.
– If it finishes above $35, you lose the entire $300 paid.
Practical exit scenarios
– Close the spread before expiration to lock in gains or cut losses.
– Let it expire if near maximum profit and transaction costs make closing unattractive.
– Be ready to manage assignment if the short put is in the money before expiration.
Common mistakes to avoid
– Ignoring commissions and slippage—these reduce net profit.
– Choosing strikes that don’t match your conviction (too wide or too narrow).
– Overlooking early assignment risk around dividends or corporate events.
– Using the strategy when you expect a large drop (in which case a naked long put or different strategy could offer higher upside).
Reputable sources for further reading
– Investopedia — Bear Put Spread: https://www.investopedia.com/terms/b/bearputspread.asp
– Cboe (Chicago Board Options Exchange) — Options Spreads: https://www.cboe.com/strategies/
– Options Industry Council — Options Basics and Spreads: https://www.optionseducation.org/
– U.S. Securities and Exchange Commission (SEC) — Investor Bulletin: Options:
– U.S. Securities and Exchange Commission (SEC) — Investor Bulletin: Options: https://www.sec.gov/oiea/investor-alerts-and-bullets/ib_options
Practical checklist — before you place a bear put spread
– Confirm market view: moderately bearish over the trade horizon (not expecting a sudden catastrophic drop).
– Choose an expiration that matches your timeframe and liquidity needs (avoid very wide spreads in illiquid expirations).
– Select strikes: buy a higher-strike put (closer to the current price), sell a lower-strike put. Strike difference defines maximum intrinsic payoff.
– Calculate net debit: premium paid for long put minus premium received for short put.
– Compute key outcomes (per share):
– Max loss = net debit.
– Max profit = (long strike − short strike) − net debit.
– Break-even = long strike − net debit.
Multiply results by the contract multiplier (usually 100) for dollar amounts.
– Enter the trade with a limit order for the net debit you accept; account for commissions and slippage.
– Plan exits: target profit, max acceptable loss, and rules for early closing or rolling.
– Confirm you have cash or margin to handle possible assignment on the short put.
Step-by-step order example (how to place it)
1. Underlying: XYZ trading at $100. You expect a modest drop.
2. Choose strikes & expiry: buy 1 XYZ 105 put expiring in 30 days; sell 1 XYZ 95 put same expiry.
3. Check prices: long 105 put costs $7.00; short 95 put receives $2.00. Net debit = $5.00.
4. Enter a single spread order (buy 1 105 put / sell 1 95 put) with limit price = $5.00 (or slightly better).
5. After fills, monitor position and adjust according to your exit rules.
Worked numeric example
– Underlying = $100. Long put strike = 105 costing $7.00. Short put strike = 95 receiving $2.00. Contract multiplier = 100.
– Net debit per share = $7.00 − $2.00 = $5.00 → Net debit per contract = $500.
– Max loss = net debit = $5.00 × 100 = $500.
– Strike difference = 105 − 95 = $10.00. Max profit per share = $10.00 − $5.00 = $5.00 → Max profit = $500.
– Break-even = long strike − net debit = 105 − 5 = $100. If stock is exactly $100 at expiration, the position pays back the net debit (breakeven).
Pay attention to the Greeks (how the spread behaves)
– Delta (directional exposure): net delta is negative (bearish), but smaller in magnitude than a single long put because you sold a put.
– Theta (time decay): typically negative for a net-debit spread — time decay works against you as expiration approaches.
– Vega (volatility exposure): usually slightly positive (long put vega > short put vega), so the spread gains if implied volatility rises; magnitude depends on strike spacing and expirations.
– Note: actual Greeks depend on strikes, time to expiration, and moneyness. Use your platform’s Greeks for precise numbers.
Managing assignment and early exercise risk
– Risk: short put can be assigned early (especially if deeply in the money and ahead of a dividend). If assigned you’ll be obligated to buy 100 shares per contract at the short strike.
– If you prefer not to be assigned, close the short leg before it becomes likely to be exercised.
– Management options if short put is in the money:
– Buy back the short put (close leg) to avoid assignment.
– Close the entire spread (buy long put and buy back short put).
– Roll the short put (buy back current short and sell a lower strike or later expiry).
– If assigned and you end up long stock, decide whether to hold the shares, sell immediately, or create a covered position (this requires cash or margin).
– Always know your broker’s assignment and margin rules.
Common exit strategies
– Close early to capture remaining time value if market moves favorably.
– Let the spread run to expiration if the expected price move
occurs and potential assignment is acceptable. That approach removes trading commissions and slippage risk from additional trades but leaves you exposed to exercise/assignment mechanics if the short put finishes in the money.
Outcomes at expiration (quick reference)
– Underlying above long (higher) strike: both puts expire worthless. Result = loss = net debit paid.
– Underlying between strikes: long put has intrinsic value, short put may be in or out of the money depending on exact price; you realize a partial payoff. Net payoff = max(K_long − S_T, 0) − max(K_short − S_T, 0) − net debit (at expiry).
– Underlying at or below short (lower) strike: both puts are in the money. Payoff equals strike difference minus net debit (maximum profit). If assignment occurs early on the short put, you may be assigned stock and still hold a long put as protection.
Key formulas
– Net debit (cost) = premium_paid_long − premium_received_short.
– Maximum profit = (K_long − K_short) − net_debit.
– Maximum loss = net_debit.
– Breakeven at expiration = K_long − net_debit.
(Where K_long is the higher strike of the long put, K_short is the lower strike, and S_T is spot at expiration.)
Worked numeric example
– Underlying current price: $100.
– Buy 1 put with strike K_long = $100 for $7.00 (debit).
– Sell 1 put with strike K_short = $90 for $2.50 (credit).
– Net debit = $7.00 − $2.50 = $4.50 (per share; options contract = 100 shares → $450).
– Max profit = ($100 − $90) − $4.50 = $5.50 → $550 per contract.
– Max loss = net debit = $4.50 → $450 per contract.
– Breakeven = K_long − net_debit = $100 − $4.50 = $95.50. If underlying $100, you lose the $4.50.
Greeks and what they imply for management
– Delta: spread delta is the difference in deltas between the long and short puts; it’s bearish but smaller than a single long put.
– Theta (time decay): on a net debit spread you pay theta (time decay hurts), but less than a long put alone because the short put’s theta offsets some decay.
– Vega (volatility): higher implied volatility increases both option prices; a rise in IV helps a long put more than a short lower-strike put, so vega is generally positive but muted versus a single long put.
– Gamma: reduced relative to a naked long put; the spread limits gamma exposure around strikes.
Assignment risk and practical notes
– American-style puts can be assigned any time prior to expiration if they are in the money. That means the short put leg can be assigned early, leaving you long 100 shares per contract.
– To avoid assignment: close the short leg before it becomes deeply in the money, or close the spread entirely.
– If assigned and you become long stock, you can:
– Hold the shares (requires cash/margin).
– Sell the shares immediately (may realize a different P/L due to fills).
– Use your long put as downside protection (effectively creating a synthetic covered position).
– Always check your broker’s margin, exercise and assignment policies and the option’s style (American vs European).
Trade checklist before entering a bear put spread
– Define hypothesis: how far and how fast you expect the underlying to fall.
– Choose strikes that match your target downside and risk tolerance.
– Calculate net debit, breakeven, max profit/loss and probability of profit.
– Check implied volatility vs historical volatility and recent IV skew.
– Ensure sufficient capital and margin to handle possible assignment.
– Set an exit plan: target profit, stop loss, or time-based exit.
– Know commissions, fees and bid-ask spreads (liquidity matters).
Example exit strategies
– Close both legs early to lock in profit if the spread reaches your target or to limit loss.
– Close only the short leg if it becomes risky to hold (e.g., deeply ITM) and you want to avoid assignment.
– Roll the short leg to a lower strike or later expiration to defer assignment risk or collect additional premium.
– Let the spread expire if you expect the market will move as anticipated and assignment risk is acceptable.
Pros and cons (summary)
– Pros: limited and known maximum loss; lower cost than a single long put; defined maximum profit; useful for moderately bearish views.
– Cons: capped upside; still subject to time decay and assignment risk; less profit potential if underlying collapses far below the lower strike.
Resources for further reading
– Cboe — Options Strategies: Bear Put Spread: https://www.cboe.com/strategies/bear-spread/
– Options Clearing Corporation (OCC) — Options Basics: https://www.theocc.com/education
– SEC — Office of Investor Education: Understanding Options: https://www.investor.gov/introduction-investing/investing-basics/investment-products/options
Educational disclaimer
This explanation is for educational purposes only and is not individualized investment advice. Option strategies involve risk and may not be suitable for all investors. Consult registered investment professionals and review your broker’s rules before trading.