Put Spread

An options strategy involving the purchase of one put option and the simultaneous sale of another put option with a lower strike price.

A put spread is an options trading strategy that involves buying and selling multiple put options on the same underlying asset with the same expiration date but at different strike prices. This strategy is primarily used by investors who expect a moderate decline in the asset's price. By combining a long put with a short put, the investor reduces the upfront cost of the trade compared to buying a single put option outright, though this also caps the maximum potential profit. To establish a standard debit put spread, an investor purchases a put option with a higher strike price and simultaneously sells a put option with a lower strike price. The premium received from selling the lower-strike put partially offsets the premium paid for the higher-strike put, resulting in a net debit. Alternatively, a credit put spread (or bull put spread) can be established by selling a higher-strike put and buying a lower-strike put to generate net premium income, which is used when an investor has a neutral-to-bullish outlook. Investors care about put spreads because they offer a defined-risk way to hedge downside exposure or speculate on falling prices. The maximum loss is strictly limited to the net premium paid to enter the trade, while the maximum profit is capped at the difference between the two strike prices minus that net premium. A common pitfall for retail investors is failing to account for transaction costs, which can eat into profits on multi-leg option strategies, or ignoring the risk of early assignment on the short leg of the spread.

An investor expects Stock XYZ, currently trading at $100, to decline. They buy a put option with a $95 strike price for $4.00 and simultaneously sell a put option with a $90 strike price for $1.50. The net cost (debit) to enter this put spread is $4.00 - $1.50 = $2.50 per share (or $250 per contract). If Stock XYZ falls to $85 at expiration, the $95 put is worth $10.00 and the $90 put is worth $5.00, making the spread worth $5.00. The investor's net profit is the final spread value minus the initial cost: $5.00 - $2.50 = $2.50 per share (or $250 total profit).