Monday, 22 April 2013

Bull Put Spread - Bullish Strategy



Bull Put Spread


Bull Put Spread is a strategy is opted when the investor is moderately bullish on the market and expects the underlying to move in upward direction in near future.

This Strategy is formed while buying of an Out of the money Put option and selling of an in the money put option of the same underlying and the same expiry.

This Strategy is also named as Bull Put Credit Spread as overall result of this strategy results in net credit of premium

Investor view: Moderately bullish on the Stock/ Index.

Risk: Limited.

Reward: Limited to the premium received.

Breakeven: Strike price of Short Put - premium received.

Illustration

Bull Put Spread Pay-off Diagram



Underlying
RELIANCE
Nifty Lot Size
250
ITM Put Option
Reliance May 800 Call Sold at Rs 30
OTM Put Option
Reliance May 780 Call Purchased at Rs 20
Total Premium Received
Rs 10 ( 30-20)
Breakeven Point
Strike Price of Short Put – Premium Received



Reward Potential

  •  Maximum Profit = Net Premium Received
  •  Profit Achieved, When Reliance Settlement Price >= Strike Price of Short Put

Risk Potential
  •  Maximum Loss = Short Put Strike Price – Strike Price of Purchased Put – Net Premium Received
  •  Max Loss, When Reliance Settlement Price  <= Strike Price of Short Put

Reliance Closing Price @
Profit/Loss
760
2500 (Loss)
780
2500 (Loss)
800
2500 (Profit)
820
2500 (Profit)
840
2500 (Profit)


Let us assume Reliance is at 780 ,investor believes that reliance is going to rally soon and forms a bull put spread by buying a May 780 put for Rs 20 and sells a MAY 800 put for Rs 30. thus, investor receives a credit of Rs 2500/- ([30-20] X 250 Lot Size )

Scenario 1 : Reliance at 840 on expiration date. Both options expire worthless and the investor is benefited with entire profit of Rs 2500 which is his maximum profit possible.

Scenario 2 : Reliance at 760 on Expiration Date. Both put options expire in-the-money with May 780 put having an intrinsic value of Rs 20/- and the May 800 put having an intrinsic value of Rs 40.so the total spread is Rs 20/- on expiry date. Since the investor had received a credit of Rs 10 while entering the spread, net loss comes to Rs 2500 ([40 - 20 ] - 10 X 250 Lot Size). This also remains his maximum possible loss.