Long Put Spread

The Strategy

A long put spread gives you the right to sell stock at strike price B and obligates you to buy stock at strike price A if assigned.

This strategy is an alternative to buying a long put. Selling a cheaper put with strike A helps to offset the cost of the put you buy with strike B. That ultimately limits your risk. The bad news is, to get the reduction in risk, you’re going to have to sacrifice some potential profit.

The Setup

• Sell a put, strike price A
• Buy a put, strike price B
• Generally, the stock will be at or below strike B and above strike A

NOTE: Both options have the same expiration month.

Who Should Run It

Veterans and higher

Break-even at Expiration

Strike B minus the net debit paid.

The Sweet Spot

You want the stock to be at or below strike A at expiration.

Maximum Potential Profit

Potential profit is limited to the difference between strike A and strike B, minus the net debit paid.

Maximum Potential Loss

Risk is limited to the net debit paid.

Ally Invest Margin Requirement

After the trade is paid for, no additional margin is required.

As Time Goes By

For this strategy, the net effect of time decay is somewhat neutral. It’s eroding the value of the option you bought (bad) and the option you sold (good).

Implied Volatility

After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices.

If your forecast was correct and the stock price is approaching or below strike A, you want implied volatility to decrease. That’s because it will decrease the value of the near-the-money option you sold faster than the in-the-money option you bought, thereby increasing the overall value of the spread.

If your forecast was incorrect and the stock price is approaching or above strike B, you want implied volatility to increase for two reasons. First, it will increase the value of the out-of-the-money option you bought faster than the near-the-money option you sold, thereby increasing the overall value of the spread. Second, it reflects an increased probability of a price swing (which will hopefully be to the downside).