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In this video, we look at the Bull Put Spread trade. This trade is placed when a trader is bullish on price, but wants to limit his possible loss to a fixed maximum amount.
The Bull Put Spread is one of the 4 most basic spread trades. The concept of the 4 basic spread trades is using two offsetting options such that the potential profit and potential loss both have fixed maximum amounts based on the difference between the premium for both options that is either collected or paid up front, and the difference between the two Strike Prices.
It is important to remember that, because a trader can either buy or sell a put option and a trader can either buy or sell a call option, the pricing of options is necessarily based on probability of outcome. Therefore, the ratio of the maximum possible profit versus the maximum possible loss is directly proportional to the probability of the trade making money.
To place a Bull Put Spread, a trader sells a Put Option and buys a Put Option with a lower strike on the same stock that both expire at the same time. The Option the trader sells has a higher strike price and therefore a higher cost, and the Option the trader buys has a lower Strike Price and a lower cost.
Because the trader is selling a Put Option with a higher Strike Price than the Put Option that he buys, the cost or Premium the trader collects up front for the Option he sold will always be higher than the cost he pays for the Option he buys. In other words, the trader collects and keeps the difference between the two premiums.
The trader's maximum potential profit for this trade is the difference between the up-front premium he collects selling the Put with the higher Strike Price and the up front premium or cost the trader pays to buy the Put with the lower Strike Price.
The trader's maximum potential loss is the difference in premiums that he collects up front minus the difference between the two Strike Prices.
Let's look at an example using GLD, the gold ETF. At the time of making this video, GLD is $126.96 a share. A trader could place a Bull Put Spread by selling the $126 Put Option and Buying the $125 Put Option. Both of these Options expire in about 5 weeks.
The $126 put option costs $1.77 and the $125 put option costs $1.37. Selling the $126 put and buying the $125 put means that the trader collects 40 cents a share up front.
The 40 cents up front premium that the trader receives is his maximum potential profit.
If the price of GLD remains above both Strike prices, both options expire worthless and the trader keeps the 40 cents that he was paid up front placing the spread.
If the price of GLD drops below $126, the put option that the trader sold begins to have intrinsic value.
If the price of GLD drops below $125, the option that the trader bought begins to have Intrinsic value. This means that for $125 and below, the loss on the Option that was sold is the same amount as the gain on the Option that was bought.
So let's break this down......
READ MORE: http://www.informedtrades.com/1679680-bull-put-spread-options-vid-24-a.html