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intro to spreads

Long Put Vertical

Analyzing the risk profile of a long put vertical

Risk Profile & Summary

Standard Setup

Long put verticals are established by simultaneously selling a lower delta put and purchasing a higher delta put. While not a requirement, the short strike is usually placed
while the long strike is placed
The strikes are often equidistant from the current share price in an attempt to create a 1:1 risk/reward ratio (meaning you can make as much as you can lose, with a 50%
Advanced traders should pay close attention to the
in both options. Selling an option with greater extrinsic value than the option you are buying will result in a POP slightly higher than 50%. This is because you would be buying the spread for less than
allowing you to take slight advantage of positive
Risk Profile: Short 25 Delta/75 Delta Put Vertical
A long put vertical is a
that allows us to cap our risk at comfortable levels. They also have a limited profit potential. You want both strikes to move
for a chance at maximum profit. If your long strike moves
you will be at risk of maximum loss.
At trade entry, long put verticals typically offer little to no
decay and often times, depending on strike selection, carry negative theta. This simply means they aren't ideal for capitalizing on the passage of time. If they carry negative theta, they will actually be disadvantaged by the passage of time giving them a lower POP. As the share price changes, so too will their theta levels. As the price gets closer to the long strike or below, theta will become more negative, and the position will feel greater pain as time passes. As the price approaches the short strike or above, theta decay will become positive and the position will benefit from the passage of time.

Why We Do This

Long put verticals are typically used as a low cost/limited risk way to bet on declining
value. Unlike some of the other strategies we've covered so far, like
or naked
typical long put verticals depend almost exclusively on directional correctness to turn a profit. If the underlying increases in value or stays the same, this strategy will likely lose money or, at best,
If you manage sell your short option for greater extrinsic value than you pay for your long option (as mentioned above), such a setup might give you a tiny amount of buffer room to be directionally wrong, however the amount may not be very significant. When established properly, your odds of profit will essentially be 50%.

The Risks

The risk of a long put vertical is realized when the underlying price rises. Maximum loss happens if the spread expires completely
The most you can lose on a long put vertical is the amount you pay for the spread. With that in mind, never buy a vertical worth more than you're comfortable losing. Long verticals do not typically have favorable odds of success, and are often disadvantaged by
contraction and the passage of time.

Summary

Assumption Bearish
A long put spread profits when the share value declines.
Cost Basis Debit
The cost basis for a long put vertical is equal to the total debit paid (plus
and fees).

Cost Basis = Debit Paid
POP ≈50%
A properly established long put vertical will have around a 50% probability of profit. Collecting a larger extrinsic value for the short option than paid for the long option can increase these odds slightly above 50%. Vise-versa, paying more extrinsic value for the long option than collected for the short can reduce the odds below 50%.
Capital Requirement Low (depending on strike width)
Depending on the width of the strikes, long put verticals typically have low capital requirements relative to other strategies. You only need enough to cover the cost of the spread. No additional capital should be required after you've paid for it.
Break Even (before commission and fees) The break-even for a long put vertical is calculated by adding the debit paid to the long strike price.

B/E = Long Strike + Debit Paid
Maximum Profit Limited
Long put verticals have limited profit potential. Max profit is calculated by subtracting the debit paid from the width of the strikes.

Max Prof = High Strike - Low Strike - Debit Paid
Maximum Loss Debit Paid
The maximum amount you can lose on long put vertical is the total debit paid.

Max Loss = Debit Paid
Capital Allocation (per position) <1% per position
Long put verticals offer little to no edge in terms of POP. There are also almost no defensive tactics should this strategy fail. The best defense is to keep these positions extra small. 1% is the most I'd be willing to risk on this type of spread.
Profit Target 25-50%
Due to the low POP, I'm generally happy with 25% of max profit. I may hold out for more if light on positions, but 50% is a homerun and an automatic close.
Delta (P/L rate of change) Negative, Dynamic
Long put verticals carry dynamic, negative delta. This means they are a bearish strategy with fluctuating delta. Delta is highest in magnitude when the share price is between the strikes, but approaches zero as the spread moves deep ITM, or far OTM.
Theta (Time decay) Reversible
Properly established long put verticals do not have a strong reliance on theta at trade entry. The extrinsic value between the short and long calls should cancel each other out or, ideally, be slightly positive. As the spread moves OTM, theta may become slightly negative. As the spread moves ITM, theta may become slightly positive.
Vega (Implied volatility sensitivity) Reversible
Vega levels can change depending on the proximity of share price to strike. If the share price approaches your short strike, vega may turn slightly negative. If it gets closer to your long strike, it may become more positive. If the share price is near your break even, vega may become more neutral. This metric can also vary with
and spread width.
Gamma (P/L Momentum) Reversible
Long put verticals carry dynamic gamma which means their gamma changes depending on the juxtaposition of the strikes and the share price. Gamma becomes most positive when the share price is near the long strike (meaning it will speed into profit, and slow into loss). It becomes most negative when it is near the short strike (meaning it will slow into profit, and speed into loss). It approaches zero as the spread moves far OTM, or deep ITM (meaning its rate of P/L should remain constant). It also approaches zero as the share price nears the center of the strikes.

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