Credit Put Spread

WHAT IS A CREDIT PUT SPREAD

Credit spreads are a strategy that can be used to generate profits not only when a stock moves in your desired direction, but also when the stock remains stationary, and even if the stock moves slightly against your desired direction.

One of the features of credit spread trades is that you receive a credit when opening the position. The advantage of receiving a credit for the trade is that you can make money on the trade even if the stock does not move. This is because of the fact that options are a wasting asset and as such the value of the spread sold decreases each day.

The two most common types of credit spreads traded are the credit put spread, and the credit call spread. The credit put spread involves the sale of a put option and the purchase of a put option at a lower strike price. The credit call spread involves the sale of a call option and the purchase of a call option at a higher strike price.

Credit Put Spread

This is a strategy that is neutral to bullish. It is limited risk, but limited reward. You would trade this strategy if you believe that the stock is likely to either appreciate prior to expiry, or alternatively not move much at all.

The sale of a put option generates a credit which is reduced by the purchase of a put option with a lower strike price. Whilst buying the put with a lower strike price reduces the credit received, it also substantially reduces the risk of the position.

The maximum profit that can be made on this position is the initial credit received, that is, the credit received for the sale of the put, minus the cost of the put which is purchased for protection. The maximum loss is the difference between the two strike prices less the initial credit received.

The maximum profit will be attained so long as the stock stays above the strike price of the sold put option. In the case where the strike price of the put option is below the current stock price, this means that the stock may even drift down a bit and still leave the position at maximum profit at expiry.

Example:
A trader believes that XYZ is likely to trade at higher prices over the next few months. It is now November and XYZ is trading at $41.00 per share. The trader trades the following spread:

Sell 10 XYZ 40.00 December Put – Receive 50c credit
Buy 10 XYZ 39.00 December Put – Pay 30c

The trader has received a net credit of 20c which equates to a $2000 credit to his/her trading account – this is because in this case each contract is over 1000 shares. The trader now has a position with a maximum risk of $8000 (the difference between the strike prices, less the premium received, multiplied by the number of shares per contract) and has received a $2000 credit for assuming this risk. As long as XYZ is trading above $40.00 per share at the date of expiry in December, the trader will keep the credit received. Even if the share price was to drop dramatically throughout the trade the trader has ensured that their maximum risk is $8000 by buying the lower strike put as protection.

To open an account to trade CREDIT PUT SPREAD follow this link and register your interest to open a Trading Account with our Preferred and Recommended Alliance Partner.

IMPORTANT
This document has been prepared without consideration of your specific investment objective. You must therefore assess whether it is appropriate, in the light of your own individual objectives, financial situation or needs, to act upon this information. While this document is based on information from sources which are considered reliable, Tangible Assets Financial Services, its directors and employees do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Tangible Assets Financial Services accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document. This document is a private communication to clients and is not intended for public circulation or for the use on any third party, without the prior approval of Tangible Assets Financial Services. AFSL 309666