10. Bear Spread

Scenario:

This trader is convinced the British Pound market is going to fall. The trader does not expect a sharp drop, just a gradual decline to about 1.5600 US$/pound. He decides on a bear spread with the written put at the target price.

Specifics:
Underlying Futures Contract:	June British Pound
Futures Price Level:	1.5850
Days to Futures Expiration:	80
Days to Options Expiration:	70
Option Implied Volatility:	12.0%
Option Position:	Long 1 Jun 1.5800 Put	-.0320 ($2000.00)
	Short 1 Jun 1.5600 Put	+ .0210 ($1312.50)
		- .0110 ($ 687.50)

At Expiration:
Breakeven:	1.5690 (1.5800 strike - .0110 debit)
Loss Risk:	Losses start above 1.5690, but limited to the debit paid. Maximum loss above 1.5800.
Potential Gain:	Gains mount as futures fall below 1.5690. Maximum profit of .0090 ($562.50) at or below 1.5600 (the difference between strikes .0200 - debit .0110).

Things to Watch:

If the trader had a target price in mind, this would be an effective strategy. Why should the trader pay for an option with unlimited potential when he thinks the move is limited? Selling an option at the target price will reduce the cost of an outright long option.

Follow-up Trading Strategies