How does a Bear Put Spread work?

How do we use a Bear Put Spread? We are looking for a stock we believe to be trending down. You create the spread by buying a Put option on bearish stock and selling a Put option on a bearish stock.

Let us analyze the stock below; we believe it is going to trend down.

It is hitting resistance ($85) and we think it will trend down to support.

We could buy a Put, if you want to be risky. Our plan is to make money even if the stock does not go down. What if we bought the $90 Put for $9 and sold the $85 Put for $5?

WHAT! I know your thinking that that is a crazy idea because $5-$9=-$4. Your thinking, I just lost money! Relax were not done yet.

Think for a moment. What would happen if the stock fell below $85 by expiration? We would be forced to buy it at $85.

But wait, don't we own the right to sell it at $90. We do! Way cool!

We can Buy the stock at $85 and sell it at $90 making $5. That is where you make money with a Bear Put Spread. Remember we originally spent $4 to do this.

Let's Show You The Money

$5-$4=$1 or 20%. In this trade your max loss is $4 and max profit is $1.

The reason this is such a good trading technique is your percentage of probability is high. The stock (which we believe is trending down) just has stay below $90.

What if you were right 90% of the time using this? Let's see...

($1)*(.90)-($4)*(.10)=$.50

That means we make an average of $.50 a trade. But we have to be able to be right 90% of the time.

Remember to paper trade until you have mastered this new strategy before putting real money into the stock market.

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