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Ineffective ETFs and Option Vertical Spreads (2/2)

1 Mar 2018,

In the previous article on vertical spreads, we have discussed the bear call spread strategy. We explained why it represents a very interesting opportunity to speculate on the decline of the underlying market, with a clear risk-profit ratio.

The same can be said about the strategy that will be the subject of today’s article, and that is the vertical bear put spread. This strategy has an identical risk profile as a bear call spread. So, why to use put option instead of call option? What are the differences?

The first elementary difference is that bear put spread is a debit strategy, ie we pay a certain premium (= our maximum loss from the trade) for entry to the trade, and we want to sell the entire structure at the maximum possible price (= difference between option strikes). While with the bear call spreads, we receive a premium bonus at the beginning, and we try to close the trade for the lowest premium (ideally, exiting the trade around USD 0).


Spread construction

Bear put spread is therefore composed of two options, the put option with a higher strike is bought (the more expensive one), and the option with a lower strike (cheaper one) is sold. The difference between the option bought and sold is therefore my cost for entering to the trade. This cost must be always lower than the difference between the strikes of both options, otherwise, I could not earn anything from the trade.

I will sustain the maximum loss if the price will be above the strike of the purchased higher option. On the other hand, the maximum gain is made if the underlying market price is during the expiration below the strike value of the lower, sold option.

Let’s take a look at the example. Current developments on the ETF: UVXY is the following – after a significant volatility spike at the beginning of February, the market is returning to a downtrend. Therefore, if we would like to speculate on the continuation of this decline, we could also speculate through the bear put spread.

Graf UVXY (zdroj: TD Ameritrade)

Fig.1: UVXY Chart (source: TD Ameritrade)


As an example, we take a combination of spreads 10 – 5 PUT, JAN19

  • Buying 10 put for -3.70
  • Selling 5 put for +0.92
  • Total cost: -2.78 (-278 USD / contract) = maximum loss – if the current price will be at expiration time above level 10
  • Max profit: spread size, ie distance between bought and sold option (ie 5 points) – 2.78 (cost) = 2.22 (222 USD / contract), if the underlying asset’s expiration value is less than 5
  • Expiration: January 2019


Diagram opční pozice - bear put spread 10-5 put JAN19 (zdroj: TD Ameritrade)

Figure 2: Diagram of the option position – bear put spread 10-5 put JAN19 (source: TD Ameritrade)

The second difference between bear call and bear put spread strategy, which is particularly important for options linked to inefficient ETFs for volatility (VXX, UVXY, …), is that the potential return on bear put spread is lower than that on bear call spreads.

Please see it on the following picture:

Srovnání bear put speadu a bear spreadu - opce 10 a 5, JAN19 (zdroj: TD Ameritrade)

Fig.3: Comparison of bear put and bear call spread – options 10 and 5, JAN19 (source: TD Ameritrade)

Bear put spread (the example above – green in the picture):

  • buying 10 – selling 5 put, expiration of JAN19
  • max. risk: USD 278 / contract
  • Max profit: 222 USD / contract

Bear call spread (highlighted in red)

  • selling 5 – buying 10 call, expiration of JAN19
  • max. risk: $ 179 / contract
  • Max profit: 321 USD / contract

(note: example calculated based on middle prices)


Why is the difference between put and call trade so big? The reason is relatively simple – the higher potential profit in the case of bear call spreads is basically a compensation for the risk of assignment (assignment of the underlying asset) due to the sold call option.

Typically, it is happening in the situation where the underlying asset has a significant borrowing fee (often reaching 20-30% p.a. or more). In such a case, it is logical that the counterparty of the trade (ie the buyer of the call option) asks for the assignment for the underlying asset that, in contrast to the option, makes an additional return of, say, around 20% pa. Also, the time value of the option plays the role for a possible assignment – when it will be close to zero (that is, for in-the-money call options), the assignment risk is of course higher.

On the other hand, it is not a problem when speaking about bear put spreads. If I buy a bear put spread, then I typically buy a spread that is positioned significantly lower than the underlying market price. I speculate on the long-term decline of the underlying market, therefore, following the current spread and probability calculation, I typically choose spreads 50-70% below the market (I use my own computational model). Both put options are OTM (out-of-the-money), assignment in this case – unlike among call options – is not possible.

Debt bear spreads are therefore a safer option in this respect, they use the characteristics of option spreads (a clearly-defined ratio of profit versus losses) but, in comparison to bear call spreads, have basically eliminated the risk of a possible assignment, ie assigning, for example, 100 pcs of underlying market (100 pcs of UVXY – ie, a “share” position) for one option contract, if the counter party asks for it (it will use so-called option exercise, which has full right for as the buyer of the option).

On the other hand, their profit potentials are sometimes tens of percent lower than bear call spreads. Therefore, the question is what variant of spreads we should choose to our portfolio?

So, what to select?

Personally, I rather prefer bear call spreads – even at the cost of the option call assignment risk. On the other hand, there are situations, typically during hot moments in the market, when the spreads made of put options allow to enter with a very interesting cost: yield ratio. Therefore, when entering the trade, I always check the potential yield the bear call spread offers as well as what identical bear put spread offers. If the difference is up to 10-15% of the potential profit from the trade, then I choose the bear put spread, otherwise, I choose bear call spread. The potential risk of assignment must simply compensate potential return on the risk – free put option.




  • Clearly given risk / profits profile
  • given the always limited risk, there is no risk during extreme movement on the underlying market (gaps, limit movements, …) against my position
  • there is no additional borrowing fee for a shorting underlying market
  • Unlike bear-call spreads, there is no risk of assignment


  • Compared to bear-call spread, lower profit potential (with identical design)
  • for someone – debit strategy = first payment is required (vs. bear call spread, where the premium is obtained directly and then I “defend” it)
  • limited defined profit (as any vertical spread)

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