Bull Put Spread for bargain hunting

This recent fall has made us both scared and excited. Scared of losing the capital already invested. And excited about the potential money makers due to the fall that has taken place. We need safety first trading strategies in times like this.

In normal situation a simple Buy Option trade would do the trick but there is one crucial way in which Options behave in times when it is rebounding from the lows. On its way down, the risk in the market increases. Fall raises premium of the options (irrespective of the prices).

Example:

1. Stock is at 100 today after rising from 90, If 100 Call is at 2

2. Same 100 Call would be trading at 3 or more if the Stock is at 100 after falling from 110.

Now imagine a Call bought after the rise in premium due to fall and then rebound takes place. The premium of the call will fall back after the rise (Case #1). This makes buying a single Call very unattractive.

On top of this there is a risk of time value degradation. For some reasons if the stock or index goes for a breather of a few days and then rises, such passage of time will push the premiums down on top of that.

Hence, one handy alterative is ATM Bull Put Spread.

Definition:

ATM: The strike we select will be close to the current market price. Since we want maximum action best place to be trading in options is in ATM strike.

Bull Put: Bull Put gives the Option type and the transaction type. Bullish position in Put option can be created by Selling a Put Option.

Spread: Spread in this case predominantly means having a simultaneous Buy and Sell positions in 2 Options of the same stock or index, same type and same expiry but of different strikes. In our case we will be buying a Lower Strike Put to make sure that we are not exposed to unlimited loss profile by just Selling the Put.

With stock trading at 100.

Sell 100 Put

& Buy 95 Put (lower strike).

This trade will have the Maximum gain of Net Premium Received. Maximum Loss will be Difference between Strikes – Maximum Gain.

Generally, Bull Put Spread will give us similar or even bigger Max Loss figure than Max Gain.

This will help in following ways:

• The drop in the Premiums due to Drop in risk will work in our favor due to more expensive Put being sold

• Rise in Stock or Index will help us get money because Put being sold

• In case there is a delay in Price action and consolidation kicks in, we will benefit then as well because we have more expensive option sold.

Exit strategy is simple. If the fall resumes, we do not wait for the rest of the expiry and get out of the trade before that. On the other hand, if the market picks up traction, then book profit and now get back to regular Bullish strategies to resume buying.