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intro to spreads

Long Put Vertical

Analyzing the risk profile of a long put vertical
You have a long put spread that is currently on the dance floor and about to expire. What would be the benefit of closing it rather than letting the options expire?
You avoid assignment
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You avoid acquiring an undefined risk position
Correct! Your short leg is OTM so it would not be "assigned." Your long leg is ITM so it would be "exercised" creating a short share position with undefined risk. Since you are on the dance floor, you would not take on a max loss even if you let it expire. You would, however, be at risk of losing more than your original maximum if the share price were to rise above your current long strike after it has been exercised.
You avoid max loss
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All of the above
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You opened a long 45/50 put spread in XYZ for $5.05. Where did you go wrong?
You bought the wrong strikes
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Looks good to me
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You shouldn't buy put spreads
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You paid more than the width of the strikes
Correct! The most this spread will ever be worth is $5. If you pay $5.05 for it you would be locking in a loss of at least $0.05 right from the start, with no chance at profit. Similarly, you wouldn't want to pay $4.95, or anywhere close to $5 because it wouldn't give you much profit potential. Ideally, you'd buy a $5-wide long vertical for around $2.50 with a 50% POP – risk one to make one.
You buy the 50/60 put spread for $5.15. What is your max potential profit?
$485
Correct! You purchased a $10-wide spread and the most you can lose is what you paid for it – $5.15. The remainder is your max potential profit: ($10 - $5.15) × 100 = $485
$515
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$10.00
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$60.00
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You bought a $10-wide put vertical in XYZ for $4.00. What would you expect your POP to be?
60%
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50%
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40%
Correct! Since you potential risk is lower than your potential reward, you know your POP must be below 50%. Divide your total risk by the width of the spread to calculate an approximate probability of profit: ($4 ÷ $10) × 100% = 40%.
Not enough info to determine
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Long put verticals are a _______ strategy?
Bearish
Correct! Long put verticals are a bearish strategy.
Safe
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Bullish
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Neutral
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Which of these is a long put vertical?
Sell the 45 call, buy the 50 put
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Sell the 35 put, buy the 45 call
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Sell the 35 put, buy the 30 put
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Sell the 45 put, buy the 50 put
Correct! You know that a long put vertical is 1 short put and 1 long put. Since the position is bearish, you know that the short strike should be lower than the long strike. A short 45 put and long 50 put satisfies both of these criteria.
You have a long 30/35 XYZ put spread. If the spread expires while XYZ is at $29.25, you will have a:
Maximum profit
Correct! Your spread would be fully ITM in this case which, for long verticals, means it is in the maximum profit zone!
Maximum Loss
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Partial Loss
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Not enough info to determine
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You have a long 30/35 XYZ put spread. Which of these scenarios would create the biggest loser at expiration?
XYZ at $35
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XYZ at $36
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XYZ at $50
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All the same
Correct! You'd be at max loss in each of these scenarios. Regardless of whether XYZ is trading for $35 or $3500 at expiration, the size of your loss would remain the same.
How can you defend a long put vertical that goes wrong?
Buy a call vertical
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Stay small at trade entry
Correct! As with all trades, your most effective defense is keeping your risk small when you first place the trade. Never bet more than you can handle losing. If a long put vertical goes against you, there's almost nothing you can do to stop it. Their success depends almost entirely on the share price going down.
Sell stock as a hedge
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Buy a cheap put
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What is the POP of a properly established long put vertical?
Around 33%
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Around 40%
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Around 50%
Correct! A properly established long put vertical will typically have around a 50% probability of profit.
Around 66%
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intro to spreads
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