Strategy description

· Buy a put, strike price B
· Sell a put, strike price A
· Generally, the stock should be above strike A

Seasoned professionals

You're bullish. You may also be anticipating neutral activity if strike A is out-of-the-money.

Strike A minus the net credit received when selling the spread.

You want the stock to be at or above strike A at expiration, so both options will expire worthless.

Potential profit is limited to the net credit you receive when you set up the strategy.

Risk is limited to the difference between strike A and strike B, minus the net credit received.

The margin requirement is the difference between the strike prices.
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NOTE: The net credit received when establishing the short put spread may be applied to the initial margin requirement.
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Keep in mind this requirement is on a per-unit basis. So don’t forget to multiply by the total number of units when you’re doing the math.

For this strategy, the net effect of time decay is somewhat positive. It will erode the value of the option you sold (good) but it will also erode the value of the option you bought (bad).

After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices. If your forecast was correct and the stock price is approaching or above strike B, you want implied volatility to decrease. That’s because it will decrease the value of both options, and ideally, you want them to expire worthless. If your forecast was incorrect and the stock price is approaching or below strike A, you want implied volatility to increase for two reasons. First, it will increase the value of the near-the-money option you bought faster than the in-the-money option you sold, thereby decreasing the overall value of the spread. Second, it reflects an increased probability of a price swing (which will hopefully be to the upside).