Make money from Falling Price Action With Bear Put Spreads

What is the difference between bear put spreads and bear call spreads, for example? Do you really understand why they are each given a name like that? This is all about getting our options trading terms correct.

Here's how it goes.

The first word in the expression signifies your opinion of the market. So a bear put spread would imply that you believe the underlying stock in question is about to take a price drop. Put simply, you're bearish on the stock, which means your vertical spread strategy will reflect that.

The next part of the expression signifies not just the kind of spread you plan to do, but once combined with the bearish nature of your outlook for the stock, shows that it's going to be a debit spread (not a credit spread). If you were doing a credit spread, you would want the underlying to remain away from the spread strike prices until option expiry date for it to be profitable. But for a debit spread you'd ideally want it to penetrate through both strike prices for maximum profit.

Bear put spreads are option debit spreads that are structured by buying put options with a strike (exercise) price which is near the current market value of the share ... and simultaneously selling the exact same number of put options at an exercise price which is lower than the bought options. Considering that the bought options will be more high priced (being nearer to the money) compared to the sold ones, the net result is a debit to your brokerage account - hence, the "debit spread" aspect of the trade.

Since we enter put debit spreads on the assumption that we could make considerable gain in the event the underlying price falls, they offer an opportunity of entering a greater number of option positions at less cost than simply buying (going long) puts. They furthermore allow greater overall flexibility should the underlying price temporarily move against us, in that we might contemplate buying back the 'sold' position at a fraction of what we sold it, in the hope that should the stock resume its downward trend, we will profit from the remaining bought put option, which at this point we own at a tremendous discount.

Bear Put Spreads must be distinguished from bear call spreads. The latter are credit spreads, again the result of a bearish view of the market but made up of call options (not put options) in the hope that the underlying stock will remain away from their strike prices.