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 [1] option trading strategy is used when an options trader believes that the price of an underlying asset [2] will increase in price, moderately, in the short term.
The put option [3] 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 [4] 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 [5] 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.