If you are new to investing chances are you haven’t heard the term “bull put spread” before. Considering that it is a more involved and advanced investment strategy, that isn’t too surprising. A bull put spread option trading strategy is used when an options trader believes that the price of an underlying asset will increase in price, moderately, in the short term.
The put option gives the investor the right to sell their investment at a specific price point in the future. It is a bit complicated to understand how it works in the real world.
Let’s say that investor A believes that a particular stock will fall in value. Right now it costs $50 per share, so he purchases a contract to sell the shares to investor B at $45 per share, and he has to pay a premium of $5 per share for the privilege. $45 is the strike price.
Let’s say that the shares do drop in price to $35, at which point investor A purchases said stocks for $3500 and sells them to investor B at the strike price of $45 or $4500 for the contract. Investor A will make a profit of $500; $3500 for the shares, plus his $500 premium taken out of $4500.
Here is the catch, though: if the stock fails to fall below that price, no transaction will occur, and investor A will lose the money he invested in the premium when he wrote the deal.
The complications involved in such deals can be significant and this really isn’t a good investment strategy for new traders.