What Is A Put Credit Spread?
Put Credit Spreads (Bear Put Spreads):
Objective: Put credit spreads aim to generate income by selling an out-of-the-money (OTM) put option and simultaneously buying an even more OTM put option.
How It Works:
Step 1: Identify an underlying stock or index.
Step 2: Sell an OTM put option (lower strike price).
Step 3: Simultaneously buy an even more OTM put option (higher strike price).
Risk and Reward:
Risk: Limited to the difference between the strike prices minus the premium received.
Reward: Limited to the premium received.
Profit Potential:
The spread profits if the underlying asset remains above the sold put's strike price.
Time decay (theta) works in your favor as the options approach expiration.
Risk Management:
Max Loss: The maximum loss occurs if the underlying asset falls below the lower strike (sold put) at expiration.
Exit Strategy:
Consider closing the spread if it reaches a certain percentage of the maximum profit.
Exit early if the underlying asset moves against your view.
Profit Potential:
Max Profit: Achieved when the underlying asset remains above the sold put's strike price at expiration.
Profit Calculation:
Max Profit = Net Premium Received (from selling the spread)
Formula:
Example:
Let's say you sell a put credit spread on Stock XYZ:
Sold Put: Strike price $100, premium received $2.
Bought Put: Strike price $95, premium paid $1.
Net premium received = $2 - $1 = $1.
Max profit = $1 (if XYZ stays above $100).
Considerations:
Probability of Success: Choose strike prices based on your confidence in the stock's movement.
Time Decay: Put credit spreads benefit from time decay.
Margin Requirements: Ensure you have sufficient margin in your account. Remember that put credit spreads are a defined-risk strategy, and while they limit potential profit, they also provide a buffer against losses.
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