What it is
You sell a put and buy a second put at a lower strike, same expiry. The one you sell brings in more than the one you buy costs, so the position opens for a net credit. It is also called a bull put spread, because it profits when the stock holds up.
The bought put is a floor. Below its strike, every dollar the sold put loses is made back by the one you own, so the loss stops growing. The distance between the strikes, less the credit, is the most the position can ever lose, and it is known the moment it opens.
What has to happen for it to make money
The stock has to finish above the break-even: the sold put's strike less the net credit. Above the sold strike both puts expire and the whole credit is kept. Between the strikes the position keeps less and less, until it reaches the full loss at the bought strike.
Like a single short put it does not need the stock to rise, only not to fall too far. Falling volatility helps while it is open, though less than it helps a single short put, because the bought put loses some value too.
Once it is on
Many traders close a credit spread before expiry, once most of the credit has been earned, because the last part of it takes the longest to collect and the risk does not shrink as fast. Close to expiry, a stock sitting between the two strikes can see the sold put assigned while the bought one is not, which leaves you holding shares you planned never to own; closing both legs together before the last day avoids that.
What goes wrong
A fall to the lower strike or beyond. That is the full loss, and on a narrow spread it is several times the credit. The cap makes the worst case survivable; it does not make it small.
Paying for the floor every time. The bought put costs premium on every trade whether the floor is ever needed or not, so the spread keeps less than a single short put in the months when nothing happens, and there are two sets of commissions and bid-ask spreads to cross.
Pros and cons
- Pro: the worst case is fixed when it opens.
- Pro: needs far less capital than securing a put with cash.
- Pro: paid when the stock rises or sits still.
- Con: keeps a smaller credit than a single short put.
- Con: the full loss is often several times the credit.
- Con: two legs to fill, and two to close.
In Restrike
The two puts fold into one position on the Log and on the Portfolio, with each leg still editable underneath. The Log states the outcome as a share of the most it could have made, and sets the win rate your spreads need, given their risk and reward, beside the win rate they actually had. Imported read-only from your broker; Restrike never places a trade.