Options Strategies: Long Put Spread Options Strategies: Long Put Spread Options Strategies: Long Put Spread

Options Strategies: Long Put Spread

Option Strategies
Peter Siks

Summary:  With a long put spread, you can anticipate a decline in the underlying value with a limited investment. While profits are capped, they are still very attractive


What is it?

A purchased put option gives the right to sell an underlying asset for a certain amount. When you write a put, you enter into an obligation to purchase.

These two trades can be combined, by buying a put (and getting a right) and at the same time selling a put with a lower strike price (take-down obligation). This is widely used and this is called a long put spread.

Why would you want to buy this?

Suppose you expect a certain stock to fall, but not indefinitely. The expected decline is a reason to buy a put, but why not take a purchase obligation at a lower level? After all, you do not expect the share to fall to € 0 and you will receive money for the obligation you enter into. In short, you reduce your investment.

Spreads have a maturity and this can vary from a few days to a few years. What you also want to know in advance is the price at which you can sell the share and for which you may have to buy. These are called the strike prices of the option and in the example below the strike prices are $140 (your right to sell) and $120 (your purchase obligation).

Example:

Let's take a look at the Apple stock. The share is currently trading around $145 and you expect a decline. You expect the share to fall towards $125 and you would like to take advantage of that. You decide to do this by buying the $125-$135 put spread.

You buy the 135 put for $7.20

You sell the 125 Put for $4.45

Example of a profit/loss chart of a long put spread from SaxoTraderGo

On balance you pay $2.75 and if your expectation comes true – the share falls towards $125– the sales right on $135 must be worth at least $10 and the purchase obligation on $125 is then worth zero.

On balance, the spread will then increase to a maximum value of $10. You can easily determine this yourself by checking what your position actually is. You may sell at $135, but you must decrease at $125. The difference between these is $10, which is also the maximum value of the spread. But you only paid $2.75 for this and you therefore make a 360% return if you saw it correctly.

When are you happy with this spread?

If the stock drops below $135. You have the right to sell at $135 and you may have to take down at $135 and you paid $2.75 for that. So you make a profit from $132.25 and lower. Optimal is, of course, a drop below $125, because then the spread will reach its maximum value.

When are you not happy?

If the stock goes up because then both options become worthless. Because who has money left over on the expiry date for a right to sell at 135 if the share can be sold on the stock exchange for $145? Exactly, nobody

When do you buy a put spread?

You buy a put spread if you think the underlying asset will fall in the coming period. You buy a put spread because the investment is smaller than just buying the put. You also sell a put and that reduces the investment. The disadvantage of this is that you maximize the chances of winning

When will you sell the purchased put spread?

You know that the maximum value of this put spread is $10. The spread will reach this value if the share is below $125 at the expiry date. But you may well be satisfied if your investment (almost) doubles to $5.50.

Perhaps the following rule of thumb can help you. Sell the spread when it trades at about 80% of its maximum value. In the case of this put spread, that would mean buying the spread at $2.75 which can be worth up to $10.00. 80% of$10 is $8. This would mean that if you can sell the spread at $8 you will have almost a 300% return.

What is your maximum risk?

The risk you run when buying the put spread is the premium you have paid. That is your maximum loss and will occur if the stock expires above the strike price you bought. In this case, it is above $135 But you can never lose more than the option premium you paid.

In short

You buy a put spread if you think the underlying asset is going to fall. You will make a great return if the expected decline actually takes place. Returns of more than 100% are then very possible.

Your maximum risk is also known in advance and that is the price you paid for the put spread. That is the maximum amount you can lose.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
Beethovenstrasse 33
CH-8002
Zurich
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law.

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.