Credit: Shutterstock photoWe're feeling bullish today. It must be something in the air. Summer is nigh, a three-day weekend is around the corner, we can practically hear Sly and the Family Stone blaring from the speakers at the neighborhood pool. It's nothing we can back up by showing you lines on a chart...but sometimes you have to go with your gut. We're just feeling bullish.
So, you probably know all about buying calls, and you may even know about long call spreads. But did you know that you can use puts to make bullish bets? Today, we're going to write about a conservative strategy called the short put spread.
Short put spread
In this strategy, you can actually be anywhere from neutral to bullish ; mainly, you're just not expecting the stock to drop during the time span of your trade. Instead, you simply want to turn a profit by selling premium.
To illustrate this strategy, we're going to turn to one of our favorite imaginary companies, Jackets Unlimited. Even though the pool opens tomorrow, fall is not that far away, and you're upbeat about the prospects for Jackets Unlimited. The shares are currently trading at $15, but you expect that they can climb as high as $25 before encountering technical resistance. Still, as good as we feel about that first visit to the pool, we're aware of the market's recent volatility, and would like to build in some protection.
To build a short put spread on Jackets Unlimited, we're going to take a rather cautious approach. Rather than selling an at-the-money 15 strike, we'll give ourselves some breathing room and sell to open a put that's a few points out of the money, at the 12.50 strike. Then, we'll buy to open a put about 5 points further south, at the 7.50 strike.
Since you're selling a higher-strike put and buying a lower strike, you'll enter the position at a net credit -- the option you bought will be worth less than the one you sold. Make sure you're happy with the amount of this initial credit, though, because it's your maximum potential profit on the trade. For this reason, the strategy is also sometimes referred to as a credit spread .
In the best-case scenario, the stock will remain above both strike prices through expiration. You'll let the puts expire worthless , and retain the initial credit as your profit. If the stock drops unexpectedly, the purchase of that lower-strike put effectively limits your potential downside. The most you can lose is the difference between the two strikes involved, minus your net credit.
On the other hand, if the stock rallies unexpectedly, you'll likely be kicking yourself for not implementing a more bullish strategy. On the plus side, some profit is better than no profit at all, right? Plus, you get to spend the weekend at the pool.
Schaeffer's Investment Research Inc. offers real-time option trading services, as well as daily, weekly and monthly newsletters. Please click here to sign up for free newsletters. The SchaeffersResearch.com website provides financial news, education and commentary, plus stock screeners, filters and many other tools. Founder Bernie Schaeffer is the author of the groundbreaking book, The Option Advisor: Wealth-Building Techniques Using Equity & Index Options .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
All Rights Reserved. Unauthorized reproduction of any SIR publication is strictly prohibited.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
