Moderately Bearish to  Bearish

The Bear put spread requires the trader to purchase a put option on an underlying stock. while simultaneously selling equal number of option contracts with the same expiration month at a lower strike price.  This strategy is also known a s a "vertical spread".  

Application

The Investor will generally use a bear put spread when he or she is moderately bearish on the underlying.  Because the investor receives a credit for the written, or sold options, the initial cost of the opportunity is lowered. The bear put spread may also be used as a repair strategy should an initial  long put purchase go the wrong way. If an investor is extremely bearish on a stock, a long put may prove to be of more benefit. 

As with the bull call spread, the bear put spread can be considered a doubly hedged strategy. As mentioned, the premium paid for the higher strike price is partially off-set by the premium collected for the written option.  The investor has therefore reduced the risk of the long put purchased by hedging it with the put sold.

As a second hedge, if the investor is assigned the written put, and must purchase the equivalent shares of the underlying at the lower strike price, the purchased put may be sold at the higher strike partially off-setting the cost of assignment.

Maximum Profit: Limited Difference Between Strike Prices - Net Debit Paid

Maximum Loss:  Limited Net Debit Paid

A bear put spread tends to be profitable when the underlying stock decreases in price. It can be established in one transaction, but always at a debit (net cash outflow). The put with the higher strike price will always be purchased at a price greater than the premium received from the written put with the lower strike price. Maximum loss for this spread will generally occur as the underlying stock price increases above the higher strike price. If both options expire out-of-the-money with no value, the entire net debit paid for the spread will be lost.

The maximum profit for the spread will usually occur when the underlying stock price decreases below the lower strike price, and both options expire in-the-money.  This will be the case no matter how low the underlying stock has dropped in price. If the underlying stock price is between the strike prices when the puts expire, the long put will be in-the-money and worth its intrinsic value. The written put will be out-of-the-money, and expire worthless.

The Implied volatility of an option is a measure of the amount by which the underlying security is expected to fluctuate over a period of time.  It reflects the markets expectations and can change at any time based on news or other events affecting the stock.

Volatility Increases:  Varies
Volatility Decreases: Varies

The effect of an increase or decrease in the volatility of the underlying stock may be noticed in the time value premiums. The net effect on the strategy will depend on whether the long and/or short options are in-the-money or out-of-the-money, and the time remaining until expiration.

A bear put  spread will not widen out to its maximum profit potential right away.  A short term increase in volatility will generally have a negative effect on this strategy.  For short-term trades, the purchase of an out-right put is generally a better alternative.

Time Decay?

Passage of Time: Varies

The effect of time decay varies depending on the relationship between the underlying share price and the strike prices of the options.  

Before expiration?

A bear put spread may be offset in one transaction, or "legged" out of, depending on the value of the position.  It is not uncommon for advanced traders to sell the long position for a profit and allow the written option to expire worthless.  This means of off-setting is not recommended for the beginner since you are left with a naked position. 

Upon Expiration?

In a situation where both options are in-the-money, the trader will generally off-set to avoid the commission costs resulting from exercise and/or assignment.  If only the purchased put is in-the-money upon expiration, the investor may choose to exercise,  off-set the entire position if possible, or off-set the profitable leg and allow the written option to expire worthless.  Regardless, this must be done prior to market close on expiration Friday.

An Example

As mentioned, if an investor is moderately negative on a stock, the bear put spread  represents a low risk, low reward strategy. The easiest way to create a bear put spread is by using put options with a strike price at or near the current market price of the underlying stock.  If the underlying stock is trading at $19.00, the bearish investor could buy a $17.50 put and correspondingly sell a $15.00 put.

If Symantec Corporation (SYMC) is trading at $19.95, the strategist may purchase 1 April $17.50 put while simultaneously selling 1 April $15.00 put.  By selling the $15.00 put, the mildly bearish investor lowers his or her risk exposure, however,  the profit potential is also compromised. The cost for the $17.50 put would be $0.55, the investor would then receive $0.15 for the sale of the $15.00 contract.  In this example, the total cost and potential loss, would be $40.00 ($0.55 x 100 - $0.15 x 100).

The maximum profit of this position is $210.00, the difference between the strike prices less the $40.00 paid to create the position. Even if the stock goes to $10.00, The investor will only make $210.00 because while the $17.50 put is worth $7.50, the 15.00 call sold is worth $5.00. To close the position, the investor would have to pay $5.00 for the $15.00 put when the $17.50 put is sold for $7.50. The limited profit potential is the price paid for lowering the risk exposure (from $55.00 to $40.00) through the bear put spread.