What is Bear put Spread/Put debit spread Option Strategy?

• A Bear Put Spread, also called Put Debit Spread, is created when the underlying view on the market is bearish, but not extremely bearish. Bear Put Spread is a net debit strategy with limited risk to limited reward. Bear Put Spread is a option trading strategy, that is executed by buying a put and selling lower strike put to fund it and reduce the execution cost, it should not be executed when we have extreme bearish bias and expect a sharp drop or plummeting underlying prices, as profit is capped on the downside.

When to Execute Put debit spread Option Strategy?

• Bear Put spread is executed when we have bearish outlook in Stock/ Index in near term. Instead of buying naked put with higher outflow, one sells a lower strike put to partially fund the outflow resulting in a hedged strategy. Identifying a clear down trend is essential for the strategy, specifically can be implemented on breakdown which helps to get the momentum, on the other hand risk is limited and will not hurt much if breakout fails to materialise. Ideal scenario to execute put debit spread is when we are expecting gradual fall in price till the sold strike price, then we can earn premium in buy put and we can have theta benefit in sold put option too.

What is the Trade?

• Buy one lot (At-The-Money) ATM Put and Sell one lot Out-of-Money (OTM) Put
  
  Alternatively,
  Buy one lot of Put option of a higher strike price and Sell one lot of Put option of a lower strike price.
  Both the Put should be of the same underlying and expiration. Breakeven for Bear Put Spread .Breakeven point = Buy Put Strike Price - net premium paid.
  Since the put of a higher strike price is bought and lower strike price is sold, the strategy is a net debit option strategy. This is referred to as put debit spread, at times.

What will be maximum profit?

• Maximum reward is limited to difference in strike less net outflow. Maximum Profit arises if the stock closes at or below the lower strike and flattens out, on further lower prices. Bear Put spreads are benefitted by two factors, a declining stock price and time decay of the short option. A gradual price drop causes the written option to decay as time progresses and the value unlocking comes from the long option which increases in value when the underlying drops.

What will be your maximum loss?

• Maximum risk is limited by the difference in cost of buy position of puts and sell position of puts,which is net premium of the put debit spread.

What are the advantages?

• Helps to participate in a bearish stock with relatively low cost. Reduced risk, cost, and breakeven point for a medium- to long-bearish bullish trade as compared to buying a put alone. Capped upside, in terms of profits. Only a purchase of a naked put means, expectation of a rapid bearish move in Nifty or the underlying, but if the bearish view going to take time to materialise, then the contrary position in put option of a different strike can help protect the overall NSE option strategy from a drop in time value of the option. (Also, referred to as theta decay, in options Greek terminology).

What are the disadvantages?

• Capped profit if the stock closes below short Put. Identifying a clear area of Support and selection of strike becomes very important.
  Example for Bear Put Spread
  Nifty fair future price 2 Feb 2023: 17956
  A Bear Put Spread can be devised by
  adding one lot of 17950 PE at 150.75
  and
  selling one lot of 17900 CE at 128
  Expiry: 2 Feb 2023
  Net Premium Paid = Rs 22.75, i.e. 22.75* 50 (lot size) = Rs 1138/-
  Maximum profit below 17900 i.e., 50 - 22.75 =27.25 i.e., difference between 17950 - 17900 = 50 - 22.75(net premium paid) = Rs 1363/-
  Maximum Loss = Rs 1138/- (i.e., net premium paid)

Impact of volatility on Bear put Spread-

• As volatility rises, option prices rise, if other factors such as underlying price and time to expiration remain constant. Since a bear put spread consists of one long put and one short put, the price of a bear put spread changes very little when volatility changes. The portfolio Vega in the discussed example shows about 1.61/50 (50 stands for lot size)=0.03, which is marginal, i.e., (while that of individual leg is about 534/50 = approx. 11).
  Note: Bear put Spread is a near-zero gamma option strategy.

Impact of time decay on Bear put Spread

• The time value of an option's total price decays as days to expiration decrease. This is known as time decay. Since a bear put spread consists of one long put and one short put, the theta decay depends on the positioning of the underlying price to the strike prices of the spread. If the underlying price is close to or above the strike price of the long put (higher strike price), then the price of the bear put spread decreases with passing of time. This happens because the long put is closest to ATM and decreases in value faster than the short put.
  However, if the stock price is near to or below the strike price of the short put (lower strike price), then the price of the bear put spread increases with passing time (and makes money). This happens because the short put is now closer to being ATM or is ATM and decreases in value faster than the long put.
  If the underlying price is in between the strike prices, then time value decay or theta decay has little effect on the price of a bear put spread, because both the long put and the short put would decay at approximately the same pace.

Example for Bear Put Spread

• Nifty fair future price 2 Feb 2023: 17956 A Bear Put Spread can be devised by adding one lot of 17950 PE at 150.75 and selling one lot of 17900 CE at 128 Expiry: 2 Feb 2023 Net Premium Paid = Rs 22.75, i.e. 22.75* 50 (lot size) = Rs 1138/- Maximum profit below 17900 i.e., 50 - 22.75 =27.25 i.e., difference between 17950 - 17900 = 50 - 22.75(net premium paid) = Rs 1363/- Maximum Loss = Rs 1138/- (i.e., net premium paid)