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When to do it
This strategy works best when the trader thinks that the pair is bearish but he is not as sure as to simply buy a Put and wants to minimise his risks.
- Buy an ITM Put at strike price B (spot +)
- Sell an OTM Put at strike price A (spot -)
- At the time of creating this strategy, the pair’s price will be between A and B.
Maximum potential profit
The maximum potential profit is limited to the difference between A and B minus the premium paid.
Maximum potential loss
The maximum potential loss is limited to the premium paid.
In the Long Put Spread, time has no significant effect as any losses suffered by time decay on the purchased Put are equalised by profits made by time decay on the sold Put.
Best/worst case scenario
The best case scenario is at A. Anything below A will not make a difference to the profit, but if the price ends up being a lot lower than A, then the trader would have been better off if he had simply bought a Put.The worst case scenario is at B or above. In this case, both options expire worthless and the trader suffers the loss of the premium.
By decreasing the strike price at A, maximum potential profit is increased, but at the same time the premium paid is increasing and the likelihood that the lower strike price will be achieved is minimised. Generally you should only set lower strike prices if you expect bearish spikes.