What is a short put vertical spread?
Short Put Vertical Summary
A short put vertical spread is a bullish position involving a short and long put with different strike prices in the same expiration.
When setting up a short put spread, the short put is more expensive than the long put since the short put is closer to the money, resulting in a net credit.
Buying a put at a lower strike price against the short put provides protection, but it also caps the [downside] profit potential.
The credit received for the short put vertical spread is an investor's max profit if it expires OTM and is worthless at expiration.
The max loss of a short vertical put spread is known upfront by subtracting the credit received from the spread width. However, losses can be more due to long stock assignment through the short put if the underlying closes and expires between the spread.
Short Put Vertical Spread
A short put vertical spread is a defined-risk bullish strategy where the trader wants the underlying price to rise. A short put vertical spread consists of two put option contracts in the same expiration: a short put closer to the stock price and a long put further out-of-the-money (OTM) than the short put. The long put that acts as a hedge in the same expiration. The short put is always more valuable than the long put in a short put vertical spread, resulting in a net credit the investor receives upfront after selling it. The goal is for the short put spread to lose value.
A defined risk spread is a strategy that caps your maximum loss potential. Max loss occurs when the underlying falls and breaches both legs of the short put vertical spread, causing both legs to go in-the-money (ITM) and trade at its full value, which is its spread width. When preparing a short put vertical spread order, you know what is at risk at order entry.
Compared to a short put on its own, one characteristic of a short put vertical is that the overall credit received is lower because it requires a long put to make it a defined risk. In other words, you must pay for protection.
However, a potential benefit of a defined-risk spread is that it requires a lower buying power requirement since we know the max loss ahead of time, which can be more capital efficient for accounts with limited buying power.
Like any other short options strategy, you will initially receive a credit when selling a put vertical spread. The value of the put spread will decrease when the underlying rises in price, which is the exactly what you want for your short put vertical spread to be profitable to keep the credit.
Additionally, the value of a short put vertical spread can decrease over time when the price of the underlying remains constant, and the spread remains OTM due to time decay. The ideal scenario for a short put vertical spread is that it remains OTM, above the short put strike, at expiration, expires worthless, and yields a max profit which is the credit received on trade entry, less commissions and fees. The trade can also be “bought back” (covered) for less than the credit received upfront to yield a profit or bought back for more than the credit received upfront to realize a loss. In other words, the trade does not need to be held to expiration.
Conversely, the max loss scenario for a short put vertical spread is that it moves in-the-money (ITM). This happens if the stock price falls and trades below the long put strike. The spread can trade for a maximum value of the distance between the strikes, and the trader would have to buy back the spread to close the trade. At expiration, max loss would be realized in this case, or the trader can buy back the spread for potentially less than max loss before expiration if they choose to exit the position.
Expiration Risk for Short Put Vertical Spreads
Additionally, any options strategy involving short options, including a short put vertical, may face after-hours risk on the day of expiration. In summary, although the vertical may have expired OTM based on the stock's closing print, an OTM short put option can become ITM based on any extreme downward price movement after the market close, resulting in an unexpected assignment of long shares. As a result, the investor would assume the risk of 100 long shares per contract assigned. The only way to eliminate after-hours risk is by closing any short options positions before expiration.
Due to the risk of getting assigned long shares, it's crucial to have a plan, like closing or rolling the position before expiration, to avoid this particular assignment risk, especially when the account does not have sufficient account equity to take on the resulting position. Please visit the Help Center to learn more about Expiration Risk.
Profit & Loss Diagram of a Short Put Vertical Spread
A short put vertical spread is a bullish trade that can yield a profit if the underlying remains above the short put strike until expiration, illustrated with a red P flag on the P/L diagram. As the share price rises or remains constant above the short put strike price, the value of the put credit spread can decrease over time depending on various factors such as changes in volatility or the velocity of the stock's price rise.
The initial credit received after selling a put vertical spread is an investor's max profit if it expires OTM and is worthless, as indicated where the green profit zone flattens above the x-axis.
Losses on the put credit spread occur when the underlying drops past the breakeven price, as illustrated where the green and red zones converge on the x-axis. As mentioned, defined-risk spreads are subject to expiration risk and are no longer defined risk if the underlying closes between the vertical spread.
Lastly, investors can experience their max loss potential on a short put vertical spread if it expires ITM entirely. However, the long put helps cap losses, as the green P flag indicates. As a result, the maximum loss on a short put vertical is the initial credit received minus the spread width, which the flattened red zone of the diagram illustrates.
What’s Required for a Short Put Vertical Spread?
Two put options in the same expiration date
One short put closer to the underlying price
One long put further out of the money or below the short put
Example of a Short Put Vertical Spread
XYZ currently trading @ $45
Sell to Open -1 XYZ 40-strike put @ $4.00 credit
Buy to Open +1 XYZ 35-strike put @ $2.00 debit
Collect a $2.00 credit ($200 total)
Spread Width = Short Strike – Long Strike = 40 – 35 = $5
Time Decay Affect | Works in your favor by decaying the value of the spread |
Max Profit | Total credit received |
Max Loss | Total credit received – (Spread width x 100 options multiplier)
$200 total credit - ($5 spread width x 100) = -$3 (-$300 total loss) |
Breakeven Price (at expiration) | Short strike price - Credit received
$40 - $2 = $38 breakeven |
Account Type Required | US options and futures margin account |
Other Names | Bull credit spread Put credit spread Short put spread Short put vertical |
