Most traders can profit from a rising market; simply buy stock, right?
But what if you could not only profit from the stock rising, but also from it going sidewards, or even falling slightly? Would that give you an edge?
The Bull Put Spread, if applied properly, will do all three of these things and give you an edge over simply buying the stock.
So what is a Bull Put Spread?
The Bull Put spread, as the name describes, is a bullish trade. If applied properly, it can also profit from sidewards movement, or even a slight fall in the market; making it an extremely versatile strategy.
So when would we use one?
Quite often when a stock is channeling, it trades between a strong resistance level, and support level. A bounce from a support level is a great indication the stock is likely to continue the pattern, go higher, and therefore provide a strong entry signal for a Bull Put spread.
When a stock is in an uptrend, you can often draw an uptrend line that represents a strong level of support. Once the stock has come back to the trend line, and bounces from that line, it is an indication that the stock is ready to continue the uptrend and therefore continue higher. This is also a strong entry signal for a Bull Put Spread.
Why would I use a Bull Put Spread?
We often apply this strategy in a way where we can place all of our risk below a strong support level. The support level then acts like a last line of defence to stop the stock from falling and going against us. If that level breaks, we often use it as a signal to exit the trade. If that support level holds, then we have the opportunity to close for 100% profit. The trade can then be exited for zero brokerage and fees, halving the cost of your trade.
The other reason traders like this strategy is it can be managed from afar. It doesn’t require too much attention, and is suitable for traders who perhaps work full time and don’t have the capacity to be actively trading day in day out.
Let’s run through an example.
The chart below is of the XJO which is an index of the top two hundred stocks of our market (by market capitalisation).
As you can see the XJO has had a decent fall since its highs back at the start of September. This downtrend was characterised by a series of lower peaks and troughs.
Recently though, you can see that the most recent peak’s apex is at the same level as the previous peak (around 5950). This is a weakening of the downtrend.
We can also see that the XJO’s last trough’s vertex was at roughly 5650, which is a major support level for the market. You can see historically the XJO has used this as a support level on numerous accounts, particularly last year when we channeled for a good four months.
Today we sit lower and at this stage you could argue the XJO may head back to 5650 or there about. We can start to consider trading a Bull Put at these levels with the idea to place all risk below the support level and let it protect the trade. Even if the market goes sidewards or falls to support, we can still make maximum profit come expiry.
We can use the support level as a technical stop, helping preserve capital if we are wrong. If the market stays above the support level by expiry we can make maximum profit and if we see a rally back towards the recent resistance of 5950 we can look to take an early profit.
This flexibility is what makes this strategy attractive as it focuses less on getting the timing right and trading purely directional.