Series 7: 5.3.3.4 Credit Put Spread

5.3.3.4  Credit Put Spread

With a credit put spread, the put you write will have a more expensive premium than the put you buy because a long put is farther out of the money. A credit put spread is also called a short put spread or a bull put spread.

Short ABC July 55 put @ 5

Long ABC July 45 put @ 1

Suppose ABC Cola is selling stock at $57 per share. You write a put with a $55 strike price and receive a premium of $5 per share. To hedge against an unexpected drop in the price of the underlying stock, you buy a put with a $45 strike for $1. Since you have taken in more than you paid (a net of $4), your spread is a credit spread. This $4 is your maximum gain, regardless of whether the stock holds steady or rises in price. If the price of the stock falls, however, your losses will be capped at $6 per share (the $10 difference in strike prices minus the $4 difference in premiums). Once the strike price for the long put is reached, any additional losses from the short put due to a further d