Position
Buy a Put Option, Sell a Lower Strike Put Option
Margin Requirement
No, pay the difference in premiums
Advantages
- Establishes a Range of Protection from lower prices
- Cost is reduced by selling lower strike put
- Higher futures price may improve your selling price
- Flexible, offset at any time and receive the remaining value
Disadvantages
- Premium paid in full at time of purchase
- Protection is limited to the lower put strike plus the cost
- Offsetting before expiration will change the cost & P/L (advantage in higher market, disadvantage in lower market)
When to Apply
- If market outlook is bullish
- If unlimited protection to lower prices is not necessary or if downside risk can be better defined or measured
- If flexibility is needed to participate in all higher prices
- If capital constraints require maximum pre-defined margin exposure
- As an adjustment to a short future, long put or short collar position after a drop in price
- If in a neutral implied volatility environment
Potential Adjustment
- In a rising market, buy back short put option to capture decay in premium, roll up long put to capture increase in price and/or sell call option to create credit to help offset initial cost
- In a falling market, roll down short put to a lower strike price to extend range of protection, roll down long put to capture gain from drop in price and/or sell call option to create credit or help offset