A bull Put spread can be profitable when the stock/index is either range-bound or rising. The concept is to protect the downside of a Put sold by buying a Put with a lower strike price, which acts as insurance for the Put sold.
The lower strike Put purchased is further out of the money (OTM) than the Put sold at a higher strike price, ensuring that the investor receives a net credit. This is because the Put purchased (further OTM) is cheaper than the Put sold. This strategy is equivalent to the Bull Call Spread but is done to earn a net credit (premium) and collect an income.
If the stock/index rises, both Puts expire worthlessly, and the investor can retain the premium. If the stock/index falls, then the investor’s breakeven is the higher strike less the net credit received. Provided the stock remains above that level, the investor makes a profit. Otherwise, they could incur a loss. The maximum loss is the difference in strikes less the net credit received. This strategy should be adopted when the stock/index trend is upward or range-bound. Let us understand this with an example.
