A bear put spread is a vertical spread consisting of being long the higher strike price put and short the lower strike price put, both expiring in the same month. The strike price of the short strike, represented by point A, is lower than the strike of the long put, point B, which means this strategy will always require the investor to pay for the trade. The short put’s primary purpose is to help pay for the long put’s upfront cost.
Profit/Loss
The max profit of a bear put spread is calculated by taking the difference between the two strike prices minus the premium paid. This is reached when the strike trades below the lower strike price at expiration.
Max loss is the cost of the trade. This is reached when the stock trades above the upper strike price at expiration.
Breakeven
The breakeven for a bear put spread is the upper strike price minus the cost of the trade.
Breakeven = long put strike – debit paid
Example
A 40-50 bear put spread costing $2.50 would consist of buying a 50-strike price put and selling a 40 strike price put, have a $10 wide strike width (50-40), which is the most the investor could make on the trade, minus the premium paid to get into the trade, in our example $2.50, leaving the investor with a max profit of $7.50.
Time decay is working against the investor if this put spread is out of the money because they need more time for this trade to become profitable. Time would be working for the investor if the vertical has both strikes in the money because they would want this trade to end, so there’s no more time for it to possibly move against them.
Conclusion
The recommendation, this is not a strategy that should be executed very often unless there is evidence of an expected downward movement. Without that, it’s a lower probability of success trade that relies on the stock to trade lower before the expiration date. It requires less capital to participate than simply purchasing stock, which means lower risk, but is still considered to be a lower probability of success trade.
