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Breakeven Point
When implementing the put backspread strategy, take note that
there are 2 break-even points, an upper breakeven point & a lower
breakeven point ...
Let's look at the upper breakeven point first, it is encountered when
...
Upper Breakeven Point = Strike Price of Short Put
($55
in the above example)
When the price of the underlying stock rises to $55.00 or more
by options expiration date, both the $55 & $50 put options would
become worthless and you incur no losses or gains.
And as for the lower breakeven point, ...
Lower Breakeven Point = Strike Price of Long Put ($50
in the above example) - Points of Maximum Loss ($5 in
the above example)
In this case, the lower breakeven price point would be $45.00
(ie. $50 - $5). If the price of the underlying stock drops to $45.00
by options expiration date, the $55 put option you sold would be
worth $1,000.00 (ie. ($55- $45) X 100). The 2 nos. of $50 put option
would also be worth $1,000.00 (ie. ($50 - $45) X 2), thus also
incurring no losses or gains.
So now that you understand the maximum loss and breakeven points of
the "put backspread" options trading strategy, what profit potential
would you expect from this technique??
Profit Potential
Well, the good thing is : the "put backspread" strategy has
unlimited profit potential. The put spread strategy makes profits
when the price of the underlying stock makes a strong move to the
downside beyond the lower breakeven point.
Assuming that the price of the underlying stock drops to $40.00,
the $55 put option you sold would go in-the-money by $15.00 and you
would incur $1,500.00 loss (ie. ($55- $40) X 100). But the 2 nos. of
$50 would be worth $2,000.00 (ie. 2 X (50 - 40) X 100), netting
you a profit of $500.00.
The following table illustrates the profit/loss outcome at various
price of the underlying stock :-
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