Bear Put Debit Spread

Bear Put Debit Spread overview

Bear put spreads, also known as long put spreads, are debit spreads that consist of buying a put option and selling a put option at a lower price. The strategy looks to take advantage of a price decrease from the underlying asset before expiration. Increased implied volatility may also benefit the bear put debit spread.

Bear Put Debit Spread market outlook

A bear put debit spread is entered when the buyer believes the underlying asset price will decrease before the expiration date. Bear put spreads are also known as put debit spreads because they require paying a debit at trade entry. Risk is limited to the debit paid at entry. The further out-of-the-money the bear put debit spread is initiated, the more aggressive the outlook.

How to set up a Bear Put Debit Spread

A bear put debit spread is made up of a long put option with a short put option sold at a lower strike price. The debit paid is the maximum risk for the trade. The maximum profit potential is the spread width minus the premium paid. To break even on the position, the stock price must be below the long put option by at least the cost to enter the position.

The closer the strike prices are to the underlying’s price, the more debit will be paid, but the probability is higher that the option will finish in-the-money. The larger the spread width between the long put and the short put, the more premium will be paid, and the maximum potential profit will be higher.

Bear Put Debit Spread payoff diagram

The bear put spread payoff diagram clearly outlines the defined risk and reward of debit spreads. Bear put spreads require a debit when entered. The debit paid is the maximum potential loss for the trade. Because a short option is sold to reduce the trade’s cost basis, the maximum profit potential is limited to the spread width minus the debit paid.

For example, if a $5 wide bear put spread costs $1.00, the maximum profit is $400 if the stock price is below the short put at expiration, and the maximum loss is $100 if the stock price is above the long put at expiration. The break-even point would be the long put strike minus the premium paid.

Entering a Bear Put Debit Spread

A bear put spread consists of buying-to-open (BTO) a put option and selling-to-open (STO) a put option at a lower strike price, with the same expiration date. This will result in paying a debit. Selling the lower put option will help reduce the overall cost to enter the trade and define the risk while limiting the profit potential.

For example, an investor could buy a $50 put option and sell a $45 put option. If the spread costs $1.00, the maximum loss possible is -$100 if the stock closes above $50 at expiration. The maximum profit is $400 if the stock closes below $45 at expiration. The break-even point would be $49.

• Sell-to-open: $50 call

• Buy-to-open: $45 call

Bear put debit spreads can be entered at any strike price relative to the underlying asset. In-the-money options will be more expensive than out-of-the-money options. The further out-of-the-money the spread is purchased, the more bearish the bias.

Exiting a Bear Put Debit Spread

A bear put spread is exited by selling-to-close (STC) the long put option and buying-to-close (BTC) the short put option. If the spread is sold for more than it was purchased, a profit will be realized. If the stock price is below the short put option at expiration, the two contracts will offset, and the position will be closed for a full profit.

For example, if a put debit spread is opened with a $50 long put and a $45 short put, and the underlying stock price is below $45 at expiration, the broker will automatically sell shares at $50 and buy shares at $45. If the stock price is above the long put option at expiration, both options will expire worthless, and the full loss of the original debit paid will be realized.

Time decay impact on a Bear Put Debit Spread

Time decay, or theta, works against the bear put debit spread. The time value of the long options contract decreases exponentially every day. Ideally, a large move down in the underlying stock price occurs quickly, and an investor can capitalize on all the remaining extrinsic time value by exiting the position.

Implied volatility impact on a Bear Put Debit Spread

Bear put debit spreads benefit from an increase in the value of implied volatility. Higher implied volatility results in higher options premium prices. Ideally, when a bear put debit spread is initiated, implied volatility is lower than it is at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Adjusting a Bear Put Debit Spread

Bear put debit spreads have a finite amount of time to be profitable and have multiple factors working against their success. If the underlying stock does not move far enough, fast enough, or volatility decreases, the spread will lose value rapidly and result in a loss. Bear put spreads can be adjusted like most options strategies but will almost always come at more cost and, therefore, add risk to the trade and extend the break-even point.

If the stock price has moved up, a bull call debit spread could be added at the same strike price and expiration as the bear put spread. This creates a reverse iron butterfly and allows the call spread to profit if the underlying price continues to increase. However, the additional debit spread will cost money and extend the break-even point.

For example, if a $5 wide call debit spread centered at the same $50 strike price costs $2.00, an additional $200 of risk is added to the trade, and the profit potential decreases by $200.

• Sell-to-open: $50 put

• Buy-to-open: $55 put

Rolling a Bear Put Debit Spread

Bear put debit spreads can be rolled out to a later expiration date if the underlying stock price has not moved enough. To roll the position, sell the existing bear put spread and purchase a new spread at a later expiration date. This requires paying another debit and will increase the risk, but will extend the duration of the trade.

For example, if the original bear put spread has a March expiration date and cost $1.00, an investor could sell-to-close (STC) the entire spread and buy-to-open (BTO) a new position in April. If this results in a $1.00 debit, the maximum profit potential decreases by $100 per contract and the maximum loss increases by $100 per contract. The new break-even price will be $48.

Hedging a Bear Put Debit Spread

Bear put debit spreads can be hedged if the underlying stock's price has increased. To hedge the bear put spread, purchase a bull call debit spread at the same strike price and expiration as the bear put spread. This would create a long butterfly and allow the position to profit if the underlying price continues to increase. The additional debit spread will cost money and extend the break-even points.