Advanced Short Bull Put Spread Strategy
At Helium Trades, we empower traders with sophisticated, empirical, and transparent tools to refine their trading strategies. This post explores the Short Bull Put Spread strategy, an advanced options trading approach tailored for a neutral to bullish market outlook. By mastering the trade mechanics, profit and loss scenarios, and greek risks, you can significantly enhance your trading acumen.
What is a Short Bull Put Spread?
A Bull Put Spread, also known as a short put spread, involves selling a put option (bullish) while simultaneously buying another put option at a lower strike price within the same expiration period (slightly bearish). This strategy generates a net credit at the outset and aims to profit from the underlying asset's price staying above the higher strike price by expiration, as well as implied volatility decreasing.
Trade risk graph where the x-axis is the price of the underlying asset and the y-axis is the profit or loss of the trade. The green line represents the trade's profit or loss at expiration, while the red line shows the trade's profit or loss at trade expiry. The blue line is Helium's expected price distribution at expiration.
How Does a Bull Put Spread Work?
The Bull Put Spread capitalizes on time decay, mean-reversion of the underlying price, and the premium differential between the sold and bought puts. Here’s a detailed breakdown:
- Sell a put option: Choose a strike price close to the current price of the underlying asset (near 50 delta).
- Buy a put option: Select a lower strike price to limit potential losses. For long tail convexity, you can buy multiple of these long put options.
- Receive net credit: The premium received from selling the put option exceeds the premium paid for the bought put option(s), resulting in a net credit.
For example, if the underlying asset is trading at $100, you might sell a put option with a strike price of $95 and buy 2 put options with a strike price of $90. If the asset remains above $95 by expiration, all options expire worthless, and you retain the net credit as profit.
Profit & Loss Scenarios for a Bull Put Spread
Understanding the profit and loss potential (and relevant proability estimates) is critical for any trading strategy. Here’s how it breaks down for a Bull Put Spread:
- Maximum Profit: For 1 x 1 spreads, the maximum profit is the net credit received when initiating the trade. This occurs if the underlying asset’s price stays above the higher strike price until expiration. However, for trades with long tail convexity (more options bought than sold), the maximum potential profit can be significantly higher!
- Maximum Loss: The maximum loss is the difference between the strike prices of the two put options, less the net credit received. This happens if the underlying asset’s price falls at the lower strike price at expiration. At Helium, all trades are risk-defined: meaning the max loss on any position is defined and (hopefully) a small fraction of your overall portfolio.
- Breakeven Point: The breakeven point is the higher strike price minus the net credit received. If the asset’s price is at this level at expiration, there is neither profit nor loss for a trade P/L of $0, although this outcome is unlikely.
- Tail Risk Protection: While initially a bullish trade (long delta), if the asset’s price falls significantly, the long put(s) provide tail convexity, resulting in large positive profits and the trade becoming short delta (bearish).
When to Use a Bull Put Spread?
The Bull Put Spread is most effective in the following market conditions:
- Neutral to Bullish Outlook: When you expect the underlying asset’s price to remain stable or rise moderately.
- High Implied Volatility: When implied volatility is high, premiums are higher, options are more expensive and the entire volatility surface (or just parts of it) are raised, allowing for a more favorable net credit.
Helium's 80% confidence interval for future volatility, or the volatility cone, is a key input for option pricing models. The wider the cone, the higher the implied volatility and the more favorable the net credit for option sellers.
Risks & Considerations for Bull Put Spreads
While the Bull Put Ratio Spread can be a profitable strategy, consider the following risks:
- Limited Profit Potential on the Upside: The maximum profit for big underlying moves to the upside is capped at the net credit received, regardless of how much the asset’s price increases. With tail convexity, big downside moves can result in large positive profits.
- Significant Downside Risk: If the asset’s price falls below the lower strike price, losses can be substantial, though limited to the spread between strike prices minus the net credit. By maximizing the size of the credit received, we can reduce the max loss.
- Time Decay: The strategy benefits from time decay, but if the asset’s price moves significantly before expiration, it can lead to losses. This is why theta (time decay) is often called the "price of gamma", or the price of being short convexity.
Theta risk graph showing the trade's profit or loss due to time decay. The x-axis is time projected into the future, while the y-axis is the profit or loss of the trade. The green line represents the trade's profit or loss at expiration, while the red line shows the trade's profit or loss at trade expiry.
Advanced Variations: Ratio Spreads
For seasoned traders, ratio spreads offer an advanced twist on the Bull Put Spread:
- Sell a 50 Delta Put and Buy Two 10 Delta Puts: This variation leverages the differential in delta values to enhance profit potential while managing risk.
- Adjusting the Ratio: Depending on market conditions and risk tolerance, adjusting the ratio of sold to bought puts can tailor the strategy to specific outlooks. Helium's Short Volatility trades automatically tries out all possible ratio combinations and decides on the rati with the best balanced risks + rewards + probabilities of profit.
Example: If the underlying asset trades at $100, sell a 50 delta put at $95 and buy two 10 delta puts at $85. This structure maximizes profit potential while strategically managing downside risk (long tail convexity).
Vega risk graph showing the trade's profit or loss due to changes in implied volatility. The x-axis is the change in implied volatility, while the y-axis is the profit or loss of the trade. The green line represents the trade's profit or loss at expiration, while the red line shows the trade's profit or loss at trade expiry.
Combining with Other Strategies
Integrating Bull Put Spreads with other strategies can enhance overall portfolio returns:
- Rolling Up: If the asset’s price is rising, close the initial Bull Put Spread and open a new one with higher strike prices to increase potential profit.
- Covered Calls: Pairing with covered calls can provide additional income and mitigate risk.
- Balance with Bearish Strategies: Combining with bearish strategies like Bear Call Spreads can hedge against downside risk and balance the overall portfolio. Helium constructs portfolios in order to be beta-neutral, or neutral to the price of SPY.
Author: Conner Lambden
Conner is the founder of Helium Trades and a former computational scientist studying the immune system. Connect with Helium on Twitter.
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