What it means
The position is a credit spread, meaning money comes in when you open it rather than going out. The sold put obliges you to buy the asset at the higher strike if the buyer exercises, and the bought put gives you the right to sell it at the lower strike, which is what limits the damage.
The view being expressed is that the price will stay above a level, not necessarily that it will rise sharply. This is why the strategy is popular with income-oriented traders: it can pay out in a market that goes up, sideways or even slightly down, provided the asset finishes above the sold strike.
The economics are the mirror image of a bull call spread. Maximum profit is the net credit received, maximum loss is the difference between the strikes minus that credit, and breakeven is the higher strike minus the credit.
The risk profile is asymmetric and people underestimate it. A typical bull put spread wins often but wins small, and the occasional loss is several times the size of a normal gain, so position sizing matters far more than the strike rate of the trades.
Margin is the practical constraint. A broker will require collateral against the maximum loss for as long as the position is open, so a trader with limited capital can hold fewer of these positions than the small upfront credit might suggest.
In practice
Real-world examples.
Example
A retired investor with a portfolio of blue-chip shares sells monthly bull put spreads on an index that he expects to hold its level. He collects roughly $300 per spread and treats the income as a supplement, sizing positions so that a maximum loss on any one spread is under 1% of the portfolio.
Example
A trader has been watching a bank share stabilise around $92 after a sharp fall. Rather than buy the shares, she sells the $90 put and buys the $85 put, which pays her $250 immediately and profits as long as the share simply avoids falling another 3%.
Example
A small hedge fund uses bull put spreads to express a view that a sector index will not break below a technical support level before quarter end. Because the strategy earns its maximum profit even if the index is flat, it fits a view about what will not happen rather than what will.
Formula
Calculation
Net credit = Premium received on the higher strike put - Premium paid on the lower strike put. Maximum profit = Net credit. Maximum loss = (Higher strike - Lower strike) - Net credit. Breakeven = Higher strike - Net credit. Suppose a share trades at $92 and you believe it will hold above $90 for the next two months. You sell one two-month $90 put for $4.00 per share and buy one two-month $85 put for $1.50 per share, with each contract covering 100 shares. Net credit is $4.00 - $1.50 = $2.50 per share, which is $250 received. Maximum profit is that $250, earned if the share finishes at or above $90 and both puts expire worthless. Maximum loss is ($90 - $85) - $2.50 = $5.00 - $2.50 = $2.50 per share, or $250, suffered if the share finishes at or below $85. Breakeven is $90 - $2.50 = $87.50. If the share finishes at $88, the sold put is exercised at a $2.00 per share cost and the bought put expires worthless, so the net result is $2.50 - $2.00 = $0.50 per share, or $50 of profit.Case study
Seen in the real world.
Ashgrove Tactical is a fictional trading firm invented to illustrate this strategy. For eighteen months it ran a consistent programme of bull put spreads on large-cap shares, targeting a net credit of about half the strike width and closing positions early once 70% of the credit had been earned.
The approach won on 43 of 50 positions, which the firm's newer traders read as evidence of an unusually reliable strategy. The risk manager pointed out the underlying arithmetic: with $250 of maximum profit and $250 of maximum loss per spread, seven full losses would wipe out the gains from twenty-eight full wins, and the winning trades were being closed early for less than the full credit.
When a sharp market fall arrived, four positions went to maximum loss in a single week. Because the firm had sized each position at 0.5% of capital rather than chasing the apparent win rate, the quarter finished roughly flat rather than badly down. This illustrative case shows why credit spreads are judged on expected value and position size, not on how often they win.
Watch out
Common mistakes.
- Judging the strategy by its win rate, when a high proportion of small wins can still be outweighed by a handful of losses that are several times larger.
- Selling the put without buying the lower-strike protection, which turns a defined-risk spread into a naked put with a very large potential loss.
- Ignoring assignment risk around dividend dates and expiry week, when an in-the-money short put can be exercised earlier than expected and leave the trader holding shares.
Questions
People also ask.
How is a bull put spread different from a bull call spread?
Both express a bullish view with capped risk, but the put version brings a credit in upfront and profits from time passing, while the call version costs money upfront and needs an actual price rise.
What happens if the share finishes between the two strikes?
The sold put is exercised and the bought put expires worthless, so the outcome falls somewhere between the maximum profit and the maximum loss depending on exactly where the price lands.
Why does the broker hold collateral?
Because the maximum loss is a real obligation, the broker requires margin equal to the strike width less the credit received until the position is closed or expires.
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