Guide to Short Put Spreads
A short put spread, sometimes called a bull put spread or short put vertical spread, is an options trading strategy that investors may use when they expect a slight rise in an underlying asset. This strategy allows an investor to potentially profit from an increase in the underlying asset’s price while also limiting losses. An investor may utilize this strategy to protect against any downside risk; the investor will know their total potential loss before making the trade.
When trading options, you have various strategies, like short put spreads, from which you can choose. The short put spread strategy can be a valuable trade for investors with a neutral-to-bullish outlook on an asset. Which options trading strategy is right for you will depend on several factors, like your risk tolerance, cash reserves, and perspective on the underlying asset.
What Is a Short Put Spread?
A short put spread is an options trading strategy that involves buying one put option contract and selling another put option on the same underlying asset with the same expiration date but at different strike prices. This strategy is a neutral-to-bullish trading play, meaning that the investor believes the underlying asset’s price will stay flat or increase during the life of the trade.
A short put spread is a credit spread in which the investor receives a credit when they open a position. The trader buys a put option with a lower strike price and sells a put option with a higher strike price. The difference between the price of the two put options is the net credit the trader receives, which is the maximum potential profit in the trade.
The maximum loss in a short put spread is the difference between the strike prices of the two puts minus the net credit received. This gives the trading strategy a defined downside risk. A short put spread does not have upside risk, meaning the trade won’t lose money if the price of the underlying asset increases.
A short put spread is also known as a short put vertical spread because of how the strike prices are positioned — one lower and the other higher — even though they have the same expiration date.
How Short Put Spreads Work
With a short put spread, the investor uses put options, which give the investor the right — but not always the obligation — to sell a security at a given price during a set period of time.
An investor using a short put spread strategy will first sell a put option at a given strike price and expiration date, receiving a premium for the sale. This option is known as the short leg of the trade.
Simultaneously, the trader buys a put option at a lower strike price, paying a premium. This option is called the long leg. The premium for the long leg put option will always be less than the short leg since the lower strike put is further out of the money. Because of the difference in premiums, the trader receives a net credit for setting up the trade.
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Short Put Spread Example
Say stock ABC is trading around $72. You feel neutral to bullish toward the stock, so you open a short put spread by selling a put option with a $72 strike price and buying a put with a $70 strike. Both put options have the same expiration date. You sell the put with a $72 strike price for a $1.75 premium and buy the put with a $70 strike for a $0.86 premium.
You collect the difference between the two premiums, which is $0.89 ($1.75 – $0.86). Since each option contract is usually for 100 shares of stock, you’d collect an $89 credit when opening the trade.
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Maximum Profit
The credit you collect up front is the maximum profit in a short put spread. In a short put spread, you achieve your maximum profit at any price above the strike price of the option you sold. Both put options expire worthless in this scenario.
In our example, as long as stock ABC closes at or above $72 at expiration, both puts will expire worthless and you will keep the $89 credit you received when you opened the position.
Maximum Loss
The maximum loss in a short put spread is the difference between the strike prices of the two put options minus the credit you receive initially and any commissions and fees incurred. You will realize the maximum loss in a short put spread if the underlying asset’s price expires below the strike price of the put option you bought.
In our example, you will experience the maximum loss if stock ABC trades below $70, the strike price of the put option you bought, at expiration. The maximum loss will be $111 in this scenario, not including commissions and fees.
$72 – $70 – ($1.75 – $0.86) = $1.11 x 100 shares = $111
Breakeven
The breakeven on a short put spread trade is the price the underlying asset must close at for the investor to come away even; they neither make nor lose money on the trade, not including commissions and investment fees.
To calculate the breakeven on a short put spread trade, you subtract the net credit you receive upfront from the strike price of the short put contract you sold, which is the option with the higher strike price.
In our example, you subtract the $0.89 credit from $72 to get a breakeven of $71.11. If stock ABC closes at $71.11 at expiration, you will lose $89 from the short leg of the trade with a $72 strike price, which will be balanced out by the $89 cash credit you received when you opened the position.
Set-Up
To set up a short put spread, you first need to find a security that you are neutral to bullish on. Once you have found a reasonable candidate, you’ll want to set it up by entering your put transactions.
You first sell to open a put option contract with a strike price near where the asset is currently trading. You then buy to open a put option with a strike price that’s out-of-the-money; the strike price of this contract will be below the strike price of the put you are selling. Both of these contracts will have the same expiration date.
Maintenance
The short put spread does not require much ongoing maintenance since your risk is defined to both upside and downside.
However, you may want to pay attention to the possibility of early assignment, especially with the short leg position of your trade — the put with the higher strike price. You might want to close your position before expiration so you don’t have to pay any potential assignment fees or trigger a margin call.
Exit Strategy
If the stock’s price is above the higher strike price at expiration, there is nothing you have to do; the puts will expire worthless, and you will walk away with the maximum profit of the credit you received.
If the stock’s price is below the lower strike price of the long leg of the trade at expiration, the two contracts will cancel each other, and you will walk away with a maximum loss.
Before expiration, however, you can exit the trade to avoid having to buy shares that you may be obligated to purchase because you sold a put option. To exit the trade, you can buy the short put contract to close and sell the long put contract to close.
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Impacts of Time, Volatility, and Price Change
Changes in the price and volatility of the underlying stock and the passage of time can affect a short put spread strategy in various ways.
Time
Time decay will generally work in favor of the short put spread. As both of the legs of the short put spread get closer to the expiration, any time value that the option contracts have will erode.
Volatility
The short put spread is more or less volatility neutral. Because you are both long and short one put option contract each, volatility in the underlying stock similarly affects each leg of the contract.
Price
A short put spread is a bullish option strategy. You have no risk to the upside and will achieve your maximum profit if the underlying stock closes above the strike price of the higher put option. You are sensitive to price decreases of the underlying stock and will suffer the maximum loss if the stock closes below the strike price of the lower put option.
Pros and Cons of Short Put Spreads
Here are some of the advantages and disadvantages of using short put spreads:
| Short Put Spread Pros | Short Put Spread Cons |
|---|---|
| No risk to the upside | Lower profit potential compared to buying the underlying security outright |
| Limited risk to the downside; maximum loss is known upfront | Maximum loss is generally larger than the maximum potential profit |
| Can earn a positive return even if the underlying does not move significantly | Difficult trading strategy for beginning investors |
Short Put Calendar Spreads
A short put calendar spread is another type of spread that uses two different put options. With a short put calendar spread, the two options have the same strike price but different expiration dates. You sell a put with a further out expiration and buy a put with a closer expiration date.
Alternatives to Short Put Spreads
Short put vertical spreads are just one of the several options spread strategies investors can use to bolster a portfolio.
Bull Put Spreads
A bull put spread is another name for the short put spread. The short put spread is considered a bullish investment since you’ll get your maximum profit if the stock’s price increases.
Bear Put Spread
As the name suggests, a bear put spread is the opposite of a bull put spread; investors will implement the trade when they have a bearish outlook on a particular underlying asset. With a bear put spread, you buy a put option near the money and then sell a put option on the same underlying asset at a lower strike price.
Call Spreads
Investors can also use call spreads to achieve the same profit profile as either a bull put spread or a bear put spread. With a bull call spread, you buy a call at one strike price (usually near or at the money) and simultaneously sell a call option on the same underlying with the same expiration date further out of the money.
The Takeaway
A short put spread is an options strategy that allows you to collect a credit by selling an at-the-money put option and buying an out-of-the-money put with the same expiration on the same underlying security. A short put spread is a bullish strategy where you achieve your maximum profit if the stock closes at or above the strike price of the put option you sold. While this trading strategy has a limited downside risk, it provides a lower profit potential than buying the underlying security outright.
Short put spreads and other options trading strategies can be complicated for many investors. An options trading platform like SoFi’s can make it easier, thanks to its user-friendly design and offering of educational resources about options. Investors have the ability to trade options from the mobile app or web platform.
FAQ
Is a short put spread bullish or bearish?
A short put spread is a neutral to bullish options strategy, meaning you believe the price of an underlying asset will increase during the life of the trade. You will make your maximum profit if the stock closes at or above the strike price of the higher-priced option at expiration.
How would you close a short put spread?
To close a short put spread, you enter a trade order opposite to the one you entered to open your position. This would mean buying to close the put you initially sold and selling to close the put you bought to open.
What does shorting a put mean?
Shorting a put means selling a put contract. When you sell a put option contract, you collect a premium from the put option buyer. You’ll get your maximum profit if the underlying stock closes at or above the put’s strike price, meaning it will expire worthless, allowing you to keep the initial premium you received when you opened the position.
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