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Put Spread
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| Risk: |
Limited |
| Reward: |
Limited |
| The Trade: |
Buy an at the money put option and sell an out of the money put. The profit will come as the share price drops. |
ABC Stock trading at £5.00
Buy 1 Sep £5.00 call and sell 1 Jun £4.50 put (see pay-off diagram below)
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| When to use: |
You think the stock will go down somewhat or at least is a bit more likely to fall than to rise. |
| Volatility expectation: |
Neutral |
| Profit: |
Limited to the difference between the two strikes (minus net premium cost). Maximum profit occurs where underlying falls to the level of the lower strike or below. |
| Loss: |
Limited to the initial premium paid in establishing the position. Maximum loss occurs where the underlying rises to the level of the higher strike or above. |
| Breakeven: |
Reached when the underlying is below the long strike price by the same amount as the net cost of establishing the position. |
| Time decay: |
Hurts but not nearly as much as a long put. |
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Trading ideas and tactics:
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- Be two dimensional - The stock is likely to move down to around £5 but not below £4
- Consider legging into them, ie maybe put the trade on in ½ size and then look to leg into the other half other
- Always ask for the strategy quote rather than the 2 options outright
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