by Dawn Pennington 07/29/08
Speaking of stocks going down, the bear-put spread strategy is a way that you can make a bet on downward trading movement.
And like its bullish counterpart that we just discussed, the bear-put spread can help you to save money on your put option trades, too.
Again, if you think a stock is going to make a significant drop, buying a put option may be your best bet. But if the pullback is looking to be a mild one, selling to open another put against it could help you to hedge your bet and limit your expenditure.
Just to review, with both the bull-call spread and with the bear-put spread, you will "buy to open" the long position and "sell to open" the short position against it.
The spreads work identically insofar as buying an option and selling one against it for a net debit -- that is, paying more for the long option and collecting a bit less for the short option position.
The difference with the bear-put spread, however, is that the strike prices you buy and sell are the mirror image of the bull-call spread. Because the stock is going down, you buy the higher-strike-price option and sell a lower-strike-price option against it.
Basically, in either case the option you choose to buy might be near- or at-the-money, which means that the strike price is close to the market price of where the stock is trading. The option you short is in the direction in which you expect the stock to go -- higher with the bull-call spread, or lower with the bear-put spread.
Let's say that the stock made the run to $25 and you profited with your bull-call spread. But suppose the company is probably going to miss its earnings expectations in the next quarter, which could knock a few points off the stock when it makes the announcement.
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