How it Works
A bear put spread is a type of options strategy where an investor expects a moderate-to-large decline in the price of a security and wants to reduce the cost of holding the option trade. A bear put spread is achieved by purchasing put options while also selling the same number of puts on the same asset with the same expiration date at a lower strike price. The maximum profit using this strategy is equal to the difference between the two strike prices minus the net cost of the trade.
Let’s say TSLA is trading at 680. We can use a bear put spread by purchasing one put option contract with a strike price of $675 for a cost of $5 and selling one put option contract with a strike price of $665 for a credit of $2. The cost of the strategy is debit paid for bought puts - credit for sold puts = $3
BTO 1 TSLA 15JUL MTHLY 675.00 PUTS Debit 5
STO 1 TSLA 15JUL MTHLY 665.00 PUTS Credit 2
BTO: Buy to Open
STO: Sell to Open
Max Profit and Max Loss
Max Profit = $7 ($10 difference in strike prices - $3 cost of trade)
Max Loss = $3
Scenario 1: What happens if trade closes the above-purchased Strike?
If it closes above the higher strike price of $675 there will be a loss of the entire amount spent to buy the spread.
Scenario 2: What happens if trade closes between strikes at expiration?
If it closes between the two strike prices, there will be a reduced profit. To avoid complexity, closing the position prior to expiration could be a good option. Speak to your broker for more information.
Scenario 3: What happens if, as the price of the security goes down, I am assigned sold puts?
With the example above, the profit from the bear put spread maxes out if the underlying security closes at or under $665, the lower strike price, at expiration. If it closes below $665 there will not be any additional profit. If you are assigned, long puts will offset assignment.
Risk Management & Strategy
Position size: 3 - 5% of your total account value
Be ok with not being able to take every trade that does not make sense money-wise in relation to your account size
If buying more than 1 contract, selling a portion as price falls is a great way to reduce risk and let the trade run without taking a significant loss if the trade goes against you.
Have a predetermined set amount you are willing to lose and gain (OCO order is a great way to take emotion out of trading)
Pro tip: knowing where there could be support and resistance will help set realistic profit and loss goals
Purchasing shorter-term call contracts with a Trail Stop, if there is a concern of short-term bull run, could help offset loss if stopped out (Hedging)