example bull put spread

An Example Bull Put Spread for General Motors

After my recent series on credit spread income trades, a number of you had questions about how to use this strategy in your account. So today, I thought I would share a real time example bull put spread.

Before we get into the details of the trade, I want to clearly state that this is not an official recommendation. Instead, this is just an example. My hope is that you can see how this kind of trade works, and set up similar trades in your own account, using your favorite target stocks.

The target stock that I’ll be using for this example is General Motors (GM)

A Brief Word About General Motors

There are a few reasons why General Motors could make a good target stock for our example bull put spread trade.

First, low interest rates have made it easier for consumers to finance auto purchases. This is true not only in the U.S. but also in other markets where GM competes.

Second, low gasoline prices makes it more affordable for drivers to own SUVs and pickup trucks. These vehicles burn much more gas than typical sedans. But when gas is cheap, this is less of an expense. For auto makers like GM, trucks and SUVs carry higher profit margins.

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Shares of GM pay a quarterly dividend of 38 cents per share. Compared to the stock price (currently near $31.65), this gives investors a dividend yield of 4.8%. Strong demand for yield should act as an incentive for investors to buy GM shares, pushing the stock higher.

Below is a chart of GM. You can see that the stock has been somewhat volatile in recent months, and is currently moving higher. Shares are firmly above the $31 level.

GM Chart 2016-08-16

I believe that these factors should push GM shares higher over the next few weeks. That’s why I would consider GM a good candidate for our example bull put spread trade.

Our Example Bull Put Spread Trade for GM

To set up our example bull put spread trade, we’ll need to sell one put contract while simultaneously buying another put contract with a lower strike price. We’ll receive income from the put contract we sell. And that income will be slightly offset by the put contract we buy.

Below is an option chain for GM with prices for call contracts on the left and for put contracts on the right. I’ve highlighted the two contracts that we’ll be using for this example bull put spread trade.

example bull put spread trade

Here are two transactions we could execute to enter an example bull put spread:

  • We could sell the GM Sept. $31 put currently bid at $0.59
  • We could buy the GM Sept. $29 put currently offered at $0.16

That means for every unit (selling one $31 put and buying one $29 put) we enter, we can expect to receive $0.59 per share, and pay $0.16 per share. That gives us net income of $0.43 per share.

Remember, each contract represents 100 shares. So for each unit we enter, we can expect to receive $43 less commissions. (As you can imagine, it is important to use a broker with a low commission structure when entering spread trades.)

Executing our Example Bull Put Spread Trade

Remember, it’s important to use a spread trade platform when entering your bull put spread trades. This way you’re able to set a fair price for both parts of your spread trade, and you can execute both simultaneously.

Below is a screenshot of the Interactive Brokers spread trade platform that I use. I’ve loaded up our GM example bull put spread trade so you can see how it looks in real time.

GM Bull put spread trade

Notice that I’ve entered a limit of $0.43. This means that I will accept only a net credit of $43 for each unit I enter (less commissions).

Also notice that the “margin impact” of this trade is $200. This means that your broker will set aside $200 while we wait for these September put contracts to expire. (More on this in just a moment.)

If you were to hit “submit order” right now, you would simultaneously sell one GM September $31 put contract and buy one GM September $29 put contract. And you would receive a net credit of at least $43 for every unit you enter.

Here’s What Can Happen…

If you were to enter this example bull put spread trade, your best outcome would occur if GM remained above $31.

If GM is trading above $31 when these puts expire, the position will simply disappear from your account. Both the $31 puts and the $29 puts will expire and you’ll be left with the $43 of income per contract that you received.

On the other hand, the worst case scenario would be if GM closed below $29.

If this were to happen, both put contracts would be “exercised.” That means the trader who bought the $31 puts from you would choose to “put” his shares to you at $31. In other words, you’ll be required to buy 100 shares of GM at $31.

At the same time, you have the right to “put” your shares to another trader at a price of $29. (That’s because you bought the September $29 put contracts). When you sell your shares at $29, you’ll realize a $2.00 per share loss.

So you’ll lose $200 on your 100 shares of GM that you bought at $31 and sold at $29. That’s why your broker set aside $200 in margin for this trade. But keep in mind, you received $43 in income from setting this trade up. So your total loss is actually only $157 (less commissions).

A third scenario could occur if GM closed between $31 and $29. In this case, you would be required to buy shares of GM at $31, but you wouldn’t automatically sell those shares at $29. You could either sell your shares at a better price (losing less than your worst case scenario of a $157 loss), or you could close out your $31 puts by buying them back before September expiration.

What Additional Questions Do You Have?

Hopefully this example helps to give you a clearer understanding of exactly how this type of strategy can work. But if you still have questions, I’d definitely love to hear them!

Simply leave a note in the comments section below, or send me an email (Zach@ZachScheidt.com) and let me know what’s on your mind. I look forward to hearing from you!

Zach Scheidt