Credit Spread - How Do You Profit With The Bull Put Spread?
The Bull Put Spread should be used when you feel positive about a stock/index that it will go up in price.
Constructing a Bull Put Spread
Simultaneously,
- Sell Higher Strike Put Option
- Buy Lower Strike Put Option with the same expiry month
Example - Bull Put Spread with 10 Contracts
If you have a bullish feeling about an Index - say, OEX, when it is trading at $570, you might enter a position on a bull put spread by selling the 565 put @ $3.00 and buying the 560 put for $2.00. The premium that you would collect upfront, in this case, would be $1,000 ($1.00 x 10 Contracts x 100 units per contract). This premium would also be your maximum profit for this position regardless on how bullish OEX may be.
Your maximum loss would be the difference between strike prices less the $1,000 credit you received for the trade. Since the difference between the strike prices is 5 (565 - 560), your maximum loss would be $4,000 ($5000 - $1000). Your return on investment would be 25% ($1000/$4000).
What is the best time to enter a Bull Put Spread?
Market Uptrends - Generally speaking, if the major indices are on strong uptrends, then you would want to focus more on bull put spreads. However, if the market is overbought, you have to be cautious with your entry. Markets, rarely, move in a straight line. A market that is overbought will come with corrections. Watch out for reversal signs.
Sideways Markets - When the major indexes have been trending sideways and are showing no strong trend in either direction, then the credit spread investor might want to have a mix of bull put spreads and bear call spreads. Since, as history would show, the indices have a tendency to move higher over time, the mix of trades should usually be biased towards the bullish side.
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