Understanding The Bear Put Spread Strategy

Sarvani Shah, having previously navigated both bullish and bearish markets, is now looking for another way to protect herself from further declines in the Nifty index. In such a case, a Bear Put Spread is a debit options strategy used when a trader expects the underlying asset to decline

In this issue, Sarvani Shah continues to adapt to a market that shows persistent bearish tendencies. As she becomes increasingly familiar with strategies suited to downward trends, her attention shifts to the Bear Put Spread. Having already worked with bearish strategies like the Bear Call Spread, Sarvani sees this new approach as another way to capitalise on market weaknesses while still controlling risk. Let’s dive into how Sarvani sets up the Bear Put Spread and compare it to her experience with the Bear Call Spread.

What is a Bear Put Spread?
A Bear Put Spread is a debit options strategy used when a trader expects the underlying asset to decline. The strategy involves buying an in-the-money (ITM) put option and simultaneously selling a put option with a lower strike price (out-of-the-money, OTM). While the trader must pay a net debit upfront, this combination allows for defined losses and profits. The strategy is most profitable when the underlying asset’s price declines but doesn’t exceed the lower strike by too much, making it ideal for moderately bearish outlooks.

A Shift to Bearish Sentiment
Sarvani, having previously navigated both bullish and bearish markets, is now looking for another way to protect herself from further declines in the Nifty index. With Nifty currently trading around 24,150, and no signs of recovery in sight, she wants to set up a strategy that could bring profits if the index continues to drop but without exposing herself to significant risk.

Why Bear Put Spread?
The Bear Put Spread is a powerful strategy when a trader expects moderate bearish moves. It offers several advantages:

1. Limited Risk: Since both the ITM and OTM puts are part of the strategy, the maximum loss is limited to the net premium paid.
2. Defined Profit: Profits are capped at the difference between the strike prices, minus the premium paid.
3. Reduced Cost: By selling an OTM put to offset some of the cost of buying the ITM put, traders can enter the trade at a lower cost than with a long-put position.

For Sarvani, this meant she could maintain a cautious bearish stance without taking on too much risk, especially when volatility was still high.

Executing the Bear Put Spread
Let’s take a closer look at Sarvani’s Bear Put Spread setup:
• Nifty Current Market Price: ₹24,150
• Sell OTM Strike 24,000 PE Price: ₹175
• Buy ITM Strike 24,200 PE Price: ₹250 n Expiry Date: November 7, 2024.

Sarvani buys the 24,200-strike put (ITM) for ₹250 and sells the 24,000-strike put (OTM) for ₹175. This results in a net debit of ₹75 (₹250 – ₹175), which represents her maximum potential loss.

Breakeven Point
The breakeven point in a Bear Put Spread is calculated by subtracting the net debit paid from the higher strike price: Breakeven Point = Higher Strike – Net Debit = 24,200 – 75 = ₹24,125. As long as Nifty stays below ₹24,125 by the expiration date, Sarvani will begin to see a profit.

Payoff Structure
The payoff structure for the Bear Put Spread is straightforward and offers defined risk and reward. Here’s what Sarvani’s potential payoff could look like based on Nifty’s closing price at expiry:

1. If Nifty closes below ₹24,000:
Both puts are in the money, allowing Sarvani to realise the maximum profit of ₹125 (difference between the strike prices minus the net debit). Maximum Profit = ₹125.

2. If Nifty closes between ₹24,000 and ₹24,200:
The ITM put makes a profit, but the OTM put incurs a loss. The net payoff = ₹(24,200 – Nifty Price) – ₹75.

3. If Nifty closes above ₹24,200:
Both puts expire worthless, and Sarvani loses the premium paid. Maximum Loss = ₹75.

Payoff Diagram

Bear Put Spread vs Bear Call Spread
While both the Bear Put Spread and Bear Call Spread are designed for bearish market conditions, they differ in their approach:

1. Market Sentiment: The Bear Put Spread profits from a moderately bearish market, while the Bear Call Spread benefits from stable or slightly bearish movements.
2. Premium Structure: The Bear Put Spread involves paying a net debit (buying premium), whereas the Bear Call Spread generates a net credit (collecting premium).
3. Risk and Reward: In the Bear Put Spread, the maximum loss is the premium paid, while in the Bear Call Spread, the maximum loss is the difference between the strike prices minus the credit received.

In Sarvani’s case, the Bear Put Spread gives her more direct exposure to downside moves in the market, while the Bear Call Spread limits her exposure to only moderately bearish conditions. Given the recent volatility, Sarvani felt that the Bear Put Spread would offer better protection while keeping her potential losses in check.

Conclusion
The Bear Put Spread provides traders with a defined-risk, moderately bearish strategy that can deliver profit even in turbulent market conditions. For Sarvani, this strategy fits perfectly with her bearish outlook, allowing her to benefit from further declines in the Nifty index while capping her losses. As she continues to learn and apply different strategies, Sarvani has developed a more balanced approach to options trading, knowing that flexibility and understanding market conditions are the keys to long-term success. Whether it’s through the Bear Call Spread or Bear Put Spread, Sarvani is well-equipped to face bearish markets with confidence.