The flip side of a bull-call debit spread, bear-put debit spreads use put options to create a position with an initial debit and a bearish slant. To create a bear-put debit spread, purchase a put at one strike price and sell another put on the same stock at a lower price in the same month. The sold put will be less expensive, so it will offset the price of the bought put, but there will still be a net debit on the trade. Typically both of these options will be in-the-money at the trade’s inception.
As long as the stock is below both strike prices at expiration, the investor will realize his maximum profit on a bear-put debit spread automatically when both puts are automatically exercised and assigned. He will sell the stock for the strike price of the higher put, then turn around and buy the same stock for the strike price of the lower put, creating a credit equal to the difference between strikes and achieving the target profit.
In the worst case, the stock reaches expiration above both puts’ strike prices. Then both options will expire worthless and the investor will lose his entire initial investment.
If the stock reaches expiration between the strike prices of the two puts, then the bought put will automatically exercise, but the sold put expires worthless. This results in a short stock position that will need to be covered immediately. To do so, buy the underlying stock at market prices. Market price will be less than we were paid upon exercising our bought put, but probably not enough to also make up for the initial debit.
Our analysts will usually exit trades that might be in trouble before expiration passes and makes the decision for us. To exit a bear-put spread, buy back the sold put and sell the bought put for a total credit.
InvestorsObserver analysts usually look for bear-put debit spread trades that have sold puts 10% or more in-the-money, so that our positions make a profit if the underlying stock falls, stays flat or even rises by a little. Trades with this amount of protection often target returns of 5-10% in just two months for annualized returns (for comparison purposes only of 30-60%.
You can find Bear-Put Debit Spreads in the Vertical Spreads Portfolio.
A similar type of trade with a bullish bias is known as a bull-call debit spread.