What is a Long Put Spread

A long put spread is defined as a bearish options approach. Traders usually use a long put spread strategy when they anticipate a decline in the underlying stock value while keeping an eye on a potential negative target. The two-tiered trading lowers the investor's start-up fee and maximizes risks on the trade compared to only purchasing a put option. This bearish options strategy is similar to short-selling a stock.

However, a bear put spread has a lower profit potential than a single long-put spread.

Long Put Spread Example

Assume that Stock XYZ is currently trading at $58, and you anticipate that the underlying value of shares will decline. However, XYZ put options are trading with comparatively high volatility impact, indicating that the contracts are now a little rich. Moreover, XYZ shares may likely find a floor near $55.

Instead of purchasing the May 59.50 put, you start a long put spread. You pay $0.40 for the May 57.50 put while simultaneously selling the May 55 strike put for $10.

You can calculate the net debit on the trade by subtracting the premium you received for selling the short put from the premium you paid for the long put. In this case, your net deficit on the trade is $0.30.

By multiplying your net debit by 100 shares per contract, you can calculate your total entry cost of $30.

Measuring Potential Profits

The long put spread will profit if Stock XYZ's value falls below $57.20 (obtained by subtracting put strike from net debit).

The best possible outcome for Stock XYZ is to settle at $55 upon expiration. This way, you can gain profit on the long-put strike, This maximum profit equals the difference between the two put options strikes minus the total debt.

In this case, ([57.50 - 55] - $30 = $2.20) $220.

The short 55 strikes put would be allowed to expire worthless in the interim. If Stock XYZ decreases by any amount less than $55, you will still get some profit. However, if you want to buy something to close your short put strike, you will need to start a new transaction.

On the other hand, breakeven is the put strike that was purchased less the net debit. In this instance, the earnings will rise until XYZ falls under $57.20. (In contrast, if you had simply bought the long put strike at the 57.50 strikes, the Stock would need to fall below $57.10 before you started to profit, as your debit would be the whole 0.40 you paid to buy the option.)

Measuring Potential Losses

On the other hand, you'll suffer losses if the value of your underlying Stock XYZ remains at or above $57.50 through expiration. In this case, you will cost the initial total debt of 0.30, or $30, which depicts the maximum loss on the put play.

Volatility Impact

In general, rising implied volatility is beneficial for option buyers. This increases the value of your option, allowing you to sell (to close) at a greater price, assuming all other conditions are equal.

However, since a long put spread entails both a purchased and a sold option, it is more difficult to determine how implied volatility may affect a long put spread. Increased implied volatility could hurt your bottom line if you have to buy (to close) the sold put.

As noted earlier, rather than buying a put option, a trader might begin a long put spread to reduce overall risk and attain breakeven on the bearish trading. However, the trade-off can yield a lower payout than a typically put play.

Why would You choose a Long-Put Butterfly Spread?

A long-put butterfly spread is a three-part approach. It is designed by buying one put-strike at a higher target price, buying one with a lower strike price, and selling two with lower strike prices. All the strike puts have the same strike prices and expiration dates.

The profit potential and risks are restricted because this strategy is designed to calculate a net debit. A trader will get maximum profit when the stock price equals the short put's strike price on expiration.

On the other hand, the maximum risk will be the total cost of long put butterfly spread, including commissions. A trader will experience loss if the stock price is below the lower and above the higher strike price at the expiration date.

The long-put butterfly spread is an advanced method because the profit potential is low in absolute terms, and costs are significantly high. There are additional commissions on the top of threefold-bid ask spreads when a trader opens the position and closes it because of three target prices. The position must therefore be opened and closed at "good strike prices." It's also crucial to determine whether the risk-to-reward ratio—which includes entry costs or commissions into account—is reasonable or favorable.

Conclusion

Compared to simple put buying, the long put spread effectively lowers a trader's cost of entry and breakeven. However, it can also limit the ability to profit from an extreme downside move. An options trader typically uses a long put spread method when he finds a potential negative target in mind or when premiums are a little higher than usual.