What it means
The strategy has two legs that share the same underlying share and the same expiry date. You buy a put with a higher strike price and at the same time sell a put with a lower strike, which leaves you paying a net debit, meaning cash goes out of your account when the trade opens.
Buying a put on its own is expensive, and its value drains away every day the share price sits still. Selling the lower-strike put recovers part of that premium, so the position costs less to hold and needs a smaller move in your favour before it breaks even.
Portfolio managers use the structure to protect a holding they do not want to sell, and traders use it to express a view that a share will drift lower over a few months. The trade-off is that the profit stops growing once the share price falls below the lower strike, so it suits a measured view rather than a crash forecast.
The maximum loss is the net debit, known before the order is placed, which makes position sizing simple. The maximum gain is the gap between the two strikes minus that debit, and the breakeven price sits at the higher strike minus the debit.
A close cousin is the bear call spread, which expresses the same directional view but opens for a net credit instead of a net debit. Choosing between them usually comes down to margin treatment, tax and whether option prices look expensive or cheap at the time.
In practice
Real-world examples.
Example
A pension fund holds 20,000 shares in a supermarket chain trading at $45 and expects a weak Christmas quarter. Rather than sell and trigger a tax charge, the manager buys 200 contracts of the $45 put and sells 200 of the $40 put for a net debit of $1.80 per share, or $36,000 in total. The position covers the first $5 per share of decline at well under the cost of an outright put.
Example
A private investor thinks a semiconductor share at $200 will drift to about $180 after soft guidance, but doubts it will crash. She buys the $200 put for $11 and sells the $180 put for $4, paying $7 per share, and accepts a capped maximum payoff of $13 per share in exchange for the cheaper entry.
Example
A company treasurer holds shares received as consideration in a takeover and cannot sell them for six months. She builds a bear put spread running to the end of the lock-up, choosing strikes so the total premium fits inside the hedging budget the board approved.
Formula
Calculation
Net debit = premium paid on the higher-strike put - premium received on the lower-strike put
Maximum loss = net debit
Maximum gain = (higher strike - lower strike) - net debit
Breakeven share price = higher strike - net debit
Shares in a listed retailer trade at $100 and you expect a fall to around $90 over three months. You buy the $100 strike put for $6.00 per share and sell the $90 strike put for $2.50 per share, both expiring in three months.
Net debit = $6.00 - $2.50 = $3.50 per share. One contract covers 100 shares, so the cash outlay is $3.50 x 100 = $350.
Maximum gain = ($100 - $90) - $3.50 = $6.50 per share, or $650 per contract.
Breakeven = $100 - $3.50 = $96.50.
If the share ends at $88, the long put is worth $12.00 and the short put costs you $2.00, leaving $10.00 per share. Subtract the $3.50 debit and the profit is $6.50 per share, or $650. If the share finishes at or above $100, both puts expire worthless and the loss is the full $350.Case study
Seen in the real world.
Northgate Optical Holdings is an illustrative family investment company that owns 30,000 shares in a listed camera retailer trading at $80. The board is nervous about a profit warning but does not want to sell a long-held stake. It buys 300 contracts of the $80 put at $5.20 and sells 300 of the $70 put at $2.20, a net debit of $3.00 per share, or $90,000.
The warning arrives and the share falls to $68. The spread is worth its maximum $10 per share, or $300,000, giving a profit of $210,000 after the $90,000 cost. The shareholding itself lost $360,000, so the net damage is $150,000 rather than $360,000.
The fictional postscript matters just as much. Had the share fallen to $50, the spread would still have paid only $300,000 while the holding lost $900,000, which is exactly the limitation the board accepted when it chose a capped structure over an outright put.
Watch out
Common mistakes.
- Treating the position like a short sale and expecting the profit to keep growing as the share falls, when in fact the payoff is fixed once the price passes the lower strike.
- Assuming any fall in the share price makes money, forgetting that the price must drop below the breakeven, not merely below where it started.
- Overlooking early assignment on the sold put, which the holder of an American-style option can exercise before expiry, particularly around a dividend date.
Questions
People also ask.
Is a bear put spread cheaper than simply buying a put?
Yes, the premium collected on the sold put reduces the net cost, though it also caps the maximum gain.
What happens if both legs finish in the money?
The two positions offset and the spread settles at the full difference between the strikes, which is the best possible outcome.
Does the strategy tie up margin?
A debit spread is normally paid for in full at the outset, so most brokers ask for nothing beyond the net debit.
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