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A spread strategy involves buying and selling options of the same category , same expiry but different strike prices.
It is done to reduce the existing risk compared to simply buy an option and paying premium.
Selling the option gets the trader premium , thereby reducing costs.
A Bull Put spread is again a bullish spread strategy which is implemented when the trader is mildly bullish on the underlying asset.
It is devised similar to a bullish call spread but instead of using calls , we use puts instead .
It involves buying a put at a lower strike price and selling a put at a higher strike price ie the put which you go long in is Out of the Money put option and the Put you sell is In the money or At the money Put Option.
We basically have a net credit of premium, when the strategy is implemented. This net credit premium will be the maximum profit of the strategy.
The maximum loss of the strategy is also limited to the extent of spread – the maximum profit of the strategy.
We must remember that whenever we are devising such strategies the underlying volatility of the strategy should decrease, for the strategy to give profit .
If the underlying asset doesn’t move and the volatility doesn’t increase in the desired direction of the trader ( which is bullish ) the trader will end up making a loss.
Let us see this with the help of an example . Long Put of Strike Price 10350 , paying a premium of 95 and selling a put of strike 10450 by receiving premium of 147. Nifty spot price is currently trading at 10360.
Here maximum loss = 48, maximum profit = Net premium inflow which is = 52 and breakevent point = lower strike price + max loss = 10398.
As can be seen from the example above the loss and profit is both limited. Maximum loss from this strategy is 48and minimum profit is 52
To conclude, we can say that the bull put spread is a great alternative to simply buy a put outright: keeping in mind when the trader is neutral to bullish price action in the underlying stock. The bull put spread reduces the break-even price and decrease the capital required to be bullish on a stock.
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