This page explains bear put spread profit and loss at expiration and the calculation of its maximum profit, maximum loss, break-even point and risk-reward ratio. Bear put spread is a bearish strategy — it profits when underlying price goes down. An alternative name for this option strategy is long put spread , which might be a bit confusing. It does not refer to the underlying price exposure which is bearish, so the word short would come to mind , but to the position in the put options themselves: If you are still confused, see a more detailed explanation here.
Bear put spread is a debit spread , which means there is a net negative cash flow when opening the position. Again, the reason is that the higher strike put that you buy is more expensive than the lower strike put that you sell. The trade has limited risk and limited profit potential. We will look at the payoff profile and the different scenarios below, using an example. The value of the position at expiration will be zero.
Maximum loss from a bear put spread trade is equal to initial cost and applies when underlying price ends up at or below the higher strike. The good thing is that the risk is limited.
Maximum possible profit from a bear put spread is the difference between the two strikes minus initial cost. It applies when the underlying ends up at or below the lower strike. When the underlying price is between the two strikes at expiration, only the higher strike put will be in the money. The lower strike put is out of the money and expires worthless.
In general, the payoff profile between the two strikes is linear and inversely related to underlying price. Near the higher strike, it approaches maximum loss. The chart below shows total profit or loss blue and contribution of the two options — the long higher strike put red and the short lower strike put green.
Total loss is constant and equal to initial cost, or maximum risk of the trade. The lower strike put is still out of the money. We have already calculated the two for our example: Different people like to express the risk-reward ratio in different ways. I like to express it as a single number — reward as multiple of risk, which in our case is 0. Bear put spread payoff profile is similar to bear call spread , which uses call options instead of puts and it is a credit spread net positive initial cash flow.
Bear put spread and bear call spread are inverse to bull put spread and bull call spread , respectively. The main difference is of course the opposite bullish exposure to underlying price.
Bear put spread is often considered a cheaper and less aggressive alternative to the plain and simple long put , which is effectively a bear put spread without the short lower strike put. The main advantages of bear put spread over long put are lower initial cost because the lower strike put you sell helps pay for the more expensive higher strike put and therefore higher break-even price and higher probability of profit.
If you don't agree with any part of this Agreement, please leave the website now. All information is for educational purposes only and may be inaccurate, incomplete, outdated or plain wrong. Macroption is not liable for any damages resulting from using the content. No financial, investment or trading advice is given at any time. Bear Put Spread Basic Characteristics Bear put spread is a bearish strategy — it profits when underlying price goes down. Buying a put with higher strike. Selling a put with lower strike and same expiration.
If you hold the options until expiration, there are three possible scenarios. Scenario 3 Between the Strikes When the underlying price is between the two strikes at expiration, only the higher strike put will be in the money. Bear Put Spread Payoff Diagram The chart below shows total profit or loss blue and contribution of the two options — the long higher strike put red and the short lower strike put green.
The general formula for bear put spread break-even point is: The general formulas for bear put spread risk and reward are the following:More...