Bear Put Spread
There is another way to take a bearish stance with vertical spreads: the bear
put spread. A bear put spread is a long put plus a short put that has a lower
strike price. Both puts are on the same underlying and share the same
expiration month. This spread, however, is a debit spread because the more
expensive option is being purchased.
Imagine that a stock has had a good run-up in price. The chart shows a
steady march higher over the past couple of months. A study of technical
analysis, though, shows that the run-up may be pausing for breath. An
oscillator, such as slow stochastics, in combination with the relative
strength index (RSI), indicates that the stock is overbought. At the same
time, the average directional movement index (ADX) confirms that the
uptrend is slowing.
For traders looking for a small pullback, a bear put spread can be an
excellent strategy. The goal is to see the stock drift down to the short strike.
So, like the other members of the vertical spread family, strike selection is
important.
Let’s look at an example of ExxonMobil (XOM). After the stock has
rallied over a two-month period to $80.55, a trader believes there will be a
short-term temporary pullback to $75. Instead of buying the June 80 puts
for 1.75, the trader can buy the 75–80 put spread of the same month for
1.30 because the 75 put can be sold for 0.45. 1
In this example, the June put has 40 days until expiration. Exhibit 9.7
illustrates the payout at expiration.