Introduction
Price spread strategy involves simultaneously buying and selling similar kind of options on the same underlying asset having same maturity/expiry date but with different strike price. That means, this strategy involves two option contracts with two different strike price creating a range having lower strike price and an upper strike price. This strategy is generally for those investors who have moderate price belief as it reduces the loss at the cost of limited gain.
Bullish PUT Price Spread involves selling/writing a PUT option at higher strike price and simultaneously buying a PUT option at a lower strike price on the same underlying asset having same maturity/expiry date.
Let us understand what is bullish PUT spread strategy using an example-
Consider an investor who is bullish on stock and expects the share price to remain above $500. His investment horizon is 1-year. Following information is available –
Share price is currently trading at $520
Put option at strike price of $500 is currently trading at a premium of $45.70
Put option at strike price of $400 is currently trading at a premium of $13.12
Case – 01: Selling a PUT Option
Investor is bullish on stock and expects the share price to remain above $500 on expiry. He can simply sell/write a PUT option at a strike price of $500 and will receive premium of $45.70.

Initial premium inflow = $45.70.
Break-even point = Strike price - Initial premium received = $500 - $45.70 = $454.30
Situation – 01: If the share price on expiry happens to be $550
PUT option lapses.
Payoff on expiry would be $0
Profit on expiry would be initial premium received = $45.70
Situation – 02: If the share price on expiry happens to be $430
PUT option gets exercised against the investor.
Payoff on expiry would be share price minus strike price = $430 - $500 = -$70
Loss on expiry would be initial premium received minus payoff = $45.70 - $70 = $24.30
Situation – 03: If the share price on expiry happens to be $380
PUT option gets exercised against the investor.
Payoff on expiry would be share price minus strike price = $380 - $500 = -$120
Loss on expiry would be initial premium received minus payoff = $45.70 - $120 = $74.30
Situation – 04: If the share price on expiry happens to be $300
PUT option gets exercised against the investor.
Payoff on expiry would be share price minus strike price = $700 - $500 = -$200
Loss on expiry would be initial premium received minus payoff = $45.70 - $200 = $154.30
Therefore, under PUT option
Maximum Loss = Share Price – Initial premium received [ maximum loss is unlimited ]
Maximum Profit = Initial premium received = $45.70 [ maximum profit is limited ].
Break-even point = Strike price - Initial premium received = $500 - $45.70 = $454.30
Case – 02: Simultaneously buying and selling PUT Options
Investor is bullish on stock and expects the share price to remain above $500. Although at the same time he is afraid that his expectations might go wrong which could lead to huge losses in case if the share price happens to be $400, $300 . . . or even $0 on expiry. Therefore, to limit the losses (which could potentially have been unlimited), he can cover his exposure by buying a PUT option at some lower strike price.
This can be done by selling/writing a PUT option at a strike price of $500 receiving a premium of $45.70 and simultaneously buying a PUT option at a strike price of $400 for which he has to pay PUT premium of $13.12.
Now, if the share price rises below $400 then investor will exercise $400 PUT option in favour and receive the payoff accordingly to offset the losses on $500 PUT option thereby creating a hedge position below $400 levels.

Net initial premium inflow = Premium received on $500 PUT – Premium paid on $400 PUT = $45.70 - $13.12 = $32.58.
Break-even point = Higher strike price - Net initial premium received = $500 - $32.58 = $467.42.
Situation – 01: If the share price on expiry happens to be $550
Both, $500 PUT & $400 PUT option lapses.
Payoff on expiry would be $0
Profit on expiry would be net initial premium received = $32.58
Situation – 02: If the share price on expiry happens to be $430
$500 PUT option gets exercised against the investor while $400 PUT option lapses.
Payoff on expiry on $500 PUT option would be share price minus strike price = $430 - $500 = -$70
Loss on expiry would be net initial premium received minus payoff = $32.58 - $70= $37.42
Situation – 03: If the share price on expiry happens to be $380
$500 PUT option gets exercised against the investor while $400 PUT option gets exercised in favour.
Payoff on expiry on $500 PUT option would be share price minus strike price = $380 - $500 = -$120 (exercised against).
Payoff on expiry on $400 PUT option would be strike price minus share price = $400 - $380 = $20 (exercised in favour)
Therefore, net payoff from the strategy = $20 - $120 = -$100
Loss on expiry would be net initial premium received minus payoff = $32.58 -$100= $67.42
Situation – 04: If the share price on expiry happens to be $300
$500 PUT option gets exercised against the investor while $400 PUT option gets exercised in favour.
Payoff on expiry on $500 PUT option would be share price minus strike price = $300 - $500 = -$200 (exercised against).
Payoff on expiry on $400 PUT option would be strike price minus share price = $400 - $300 = $100 (exercised in favour)
Therefore, net payoff from the strategy = $100 - $200 = -$100
Loss on expiry would be net initial premium received minus payoff = $32.58 -$100= $67.42
Therefore, under Price Spread Strategy
Maximum Loss = Difference of strike price – Net initial premium received = ($500 - $400) - $32.58 = $67.42 [ maximum loss is limited ]
Maximum Profit = Net initial premium received = $32.58 [ maximum profit is limited ].
Break-even point = Higher strike price - Net initial premium received = $500 - $32.58 = $467.42.

Benefits of Price Spread Strategy
Under situation – 04 of both the cases, the loss from the Price Spread Strategy is lower and limited to $67.42 as compared to selling a PUT option in case – 01 were losses are higher and can lead to huge [ limited losses on expiry because of offsetting position in $400 PUT option ].
Drawbacks of Price Spread Strategy
Under situation – 01 of both the cases, the loss of initial premium received is lower in Price Spread Strategy as compared to selling a PUT option in case – 01 [ lower initial premium resulting in lower profit ].
Break-even point in Price Spread Strategy is higher as compared to selling a PUT option in case – 01 [ faster break-even because of lower initial premium ].
Recommendation to the investor
Bullish PUT Price Spread Strategy should be employed if the investor wants to limit the losses, at the cost of lower gains, incase share price falls steeply (say share price on expiry rises to $400, $300 . . . and so on). This strategy helps investor to limit the losses by offsetting the risk of selling the higher strike price option with the lower strike price option. Ultimately resulting in limited profit of $32.58 and limited loss of $67.42, while in case – 01 i.e., selling only a PUT option can result in unlimited loss.
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