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Let's say I've written at put at 50 (naked put). The stock price has come down from 57 to 52. I want to reduce my exposure. Is buying a put and creating a credit spread a good strategy for this scenario?

Sold 1 contract of ABC 50 put at $1.00
Stock price = 52
ABC 50 current premium = 2
Unrealized loss = $100

To reduce potential losses:

buy 1 ABC 45 puts for .75

Net spread: 1.00 - .75 = $0.25 x 100 = $25

Break even: 50 - .25 = 49.75
Max profit: .25 x 100 = $25 (vs. $100)
Max loss: 5 - .25 = $475

If this expires below 50, I could get assigned the 50 put right?

Also, are the above calculations correct?

If the stock were to drop to 44, I'd be out $475 on the spread.

It seems comparable on the naked put after assignment (600 - 100 = $500)

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Your calculations are correct.

Is buying a put and creating a bear credit spread a good strategy for this scenario?

Yes, if the stock is below $49.75 at expiration. If not, not so much.

Since you didn't provide the expiration date, I'm just guessing here but had you bought the $45 put when you initiated your position, I'd bet that it might have cost 25 cents or or so. Here's my two cents on this:

A vertical is a risk defined strategy.

A short put has an imbalanced R/R ratio since the potential loss could be anything (down 2, 5, 10, 25 pts below strike). A vertical shifts the R/R closer to even and has a lower margin requirement.

Prior to expiration, the vertical will lose less than the short put because the long put gains in value as the underlying drops.

Comparing the strategies, at expiration, the break for the vertical versus the short put is the long put strike less the premium paid for it. Above that that break even point, the short put outperforms. Below it, the vertical loses nothing more while the short put continues to lose.

FWIW, higher vols provide a larger spread credit. Lower vols presents a more challenging choice.

The short answer? You get a much higher ROI with a vertical and no chance of getting whacked if the stock collapses. Is giving up a small piece of the short premium worth the higher ROI and disaster protection? That's a personal choice. I say yes.

  • Thanks! From the example above, if the stock ends up at 44 at expiration, the naked put and spread come out with similar loss results? Of course, with the naked option, once you are put at 50, then price can continue going below 44, increasing your loss. In that case, the spread wins. By the way, the put was bought after the fact so I'm guessing that will always result in a less optimal spread. – 4thSpace Dec 15 '18 at 3:14
  • The long put is $45 and it cost 75 cents. That makes break even $44.25 (long strike less premium paid for it). At $44.25 the naked put has an intrinsic value of $5.75 (loss) and since you took in $1 for it, your loss is -$4.75 . The vertical took in 25 cents so the most you can lose is $4.75 and that occurs at or below $44.25 . So as you noted, below $44.25 the naked put keeps losing but the spread does not. – Bob Baerker Dec 15 '18 at 3:32
  • Two questions: 1.) If the stock price stays above 50 at expiration, I collect the full $25 credit? 2.) If the stock price is at B.E. at expiration, I get assign the short put? – 4thSpace Dec 17 '18 at 20:26
  • If your puts are at or above strike at expiry they will expire worthless. Subtle point to note is that they may trade ITM during the day, end up OTM and be exercised. The OCC will automatically exercise all options (long and short) that are 1 cent or more ITM at expiry (Exercise by Exception). For equity options, you'll end up with a position in the underlying. Index options are cash settled. If long the option, you can designate via your broker that your options are not auto exercised at expiry. This would make sense if pennies ITM and commission to close exceeds the net ITM amount. – Bob Baerker Dec 18 '18 at 13:51
  • I think this is called a bull credit spread and not a bear credit spread right? A bull credit spread is neutral to bullish, which is what this strategy is. – 4thSpace Dec 20 '18 at 16:35

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