What is Bull Put Spread?

If you ask any successful investor or trader how they have successfully navigated through the ups and downs of the Indian financial market, the answer would always be the same: Diversification. Successful investors have immense knowledge about the factors that result in price fluctuation. They tend to invest so that they realize profits in another asset class if one falls. Diversification is the holy grail to never lose out on profits.

Apart from stocks, the preferred asset class is Derivatives. A derivative instrument derives its value from the underlying asset. The asset can be equity, a commodity, a currency, or even an index. Derivatives are usually in the form of a contract, where the buyer is obligated to buy, or the seller is obligated to sell the underlying asset at a specified price and date in the future.

Between the two methods: Options and Futures contracts, a large number of investors choose options trading, and within it, a bull market strategy called Bull Put Spread. However, to understand the meaning of bull put spread and how it can help you diversify and make profits, let’s cover the basics.

What is Options Trading?

An options trading contract is generally permitted in top assets wherein the trader has the right but not a legal obligation to buy/sell the purchased security at a fixed price. Such a contract helps investors make a profit based on price fluctuations without having to buy/sell the contract.

Types of Options Contract

Call Options

A call option is a contract wherein you win the right, but not the obligation, to buy a certain underlying asset at a decided-upon price and date between the contracting parties.

Put Options

A Put option works exactly opposite to the call option. While the call option equips you with the right to buy, the put option empowers you with the right to sell the stock at the date agreed upon by the contracting parties.

Some terms associated with Bull Put spread

Before you jump to understand bull put spread, it is crucial to understand the following terms:

• Strike Price: The price at which the options contract was initially bought or the pre-determined price.
• Spot Price: The current price of the underlying asset attached with the put option contract.
• Premium: It is the price you pay to the seller of the option for entering into the online trading options.
• In-The-Money (ITM) call option: When the underlying asset price is higher than the strike price.
• Out-of-the-money (OTM) call option: When the underlying asset price is lower than the strike price.

Going through the above terms, you will understand the basic terms required for understanding the bull put spread definition.

What is Bull Put Spread?

There are mainly two natures of the stock market: bullish and bearish. Bullish is when the asset prices are rising, and bearish is when they are falling. Options traders use a bull put spread strategy to make profits in the bullish market.

A bull put spread is an options trading strategy in which the trader buys and sells the same number of put options of different strike prices with the same underlying asset and expiration date. The strategy involves selling an in-the-market put option and buying an out-of-the-market put option and realizing profits based on the net premium received.

Example of Bull Put Spread

Here is an example of bull put spread to let you understand bull put spread meaning:

An investor buys a bull put spread with a strike price of Rs 80, a premium of Rs 15, which expires in December 2021. Simultaneously, the investor sells a put option with a strike price of Rs 120, a premium of Rs 35, and the same expiration date. The underlying asset for both of the options is the same and is currently trading at Rs 95.

The net premium received: Rs 35
Net premium paid: Rs 15
Total profit: Rs 20

Now, consider the following table of the possible price scenarios of the underlying asset at the time of the expiry:

Considering the above example of bull put spread:

Any price of Rs 120 or above will cap the profit of the investor at Rs 20 as both the short and long-put options will be out-of-the-money.

Any price of Rs 80 or below will cap the loss of the investor at Rs 20 as both the short and long-put options will be in the money.

Thus, in using a bull put spread, an investor is limited to the maximum loss that is equal to the difference in strike prices of the short and long put options plus the net premium received. The strategy is limited to the maximum gain equal to the net commission/premium received.

Maximum Profit = Rs 20
Maximum Loss = Rs 20 (120-80)
Break-even point = Rs 100 (120-20)

Advantages and Disadvantages of Bull Put spread

Just like any other strategy, bull put spread is also not without its advantages and disadvantages.

Benefits of a bull-put trade:

• You can earn profits from the net credit of premium at the onset of the strategy.
• The maxim loss is always capped, and the investors know the exact amount they stand to lose.
• There is less chance of losses if the market is constantly bullish.
• A bull put spread helps you profit from three situations: sideways movement, rise, and marginal fall.

Drawbacks of bull-put trade:

A bull put spread is a complex yet rewarding options trading strategy for you to diversify within the various asset classes. If you want to realize profits in a bull market, you can open an F&O trading account with IIFL and start options trading. You can open it by following these steps:

• The profits are not that significant and may force you to take unnecessary risks for big profits.
• You may miss out on future gains if the asset price rises above the upper strike price.
• Time decay may also force you to incur losses in a bull put spread.
• The execution of a bull put spread needs extensive knowledge of the financial market.
• Visit www.indiainfoline.com or the IIFL share market app. Click on open a trading account» Enter Basic details.
• You will receive a one-time password (OTP) on the mobile number.
• You will receive a link on your registered email id. You need to enter the OTP received on your registered email id.
• After verifying the OTP, you need to fill out the online Account Opening Form.
• Your Relationship Manager will then contact you for the necessary documentation.
• Once the documentation process is completed, and the forms are received at HO, the account will be opened within 24 hours.

Options can provide opportunities when leveraged correctly and can be harmful when used incorrectly. If you're well versed in online trading options, there are sophisticated trading strategies in India such as a bear call spread; bear put spread, bull call spread, and bull put spread that you can use to optimize returns. "It is always wise to consult the financial advisors of IIFL before you execute any of the options trading strategies. Meanwhile, check out the put call ratio indicator at IIFL to learn the market sentiments when it comes to put and call options traded."