It’s often said that when the volatility is high, we want to sell Options.

And when the volatility is low, we want to buy Options.

So when the volatility is low and you want to Short the market, which strategy should you use?

The answer: Bear Put Spread (aka Put Debit Spread or Long Put Vertical Spread).

In fact, the Bear Put Spread is my favorite low-volatility strategy because it is a positive expectancy strategy by default.

## The Bear Put Spread

So what exactly is the Bear Put Spread?

The Bear Put Spread is made up of two single Options:

- Long Put
- Short Put

The Long Put is usually placed either At-The-Money (ATM) or In-The-Money (ITM) above the current price.

If you use an ATM Long Put, you will have a better risk-to-reward ratio, but the tradeoff is that you have a lower win rate.

If you use an ITM Short Put, you will have a higher win rate, but the tradeoff is a worse risk-to-reward ratio.

As for the Short Put, we want to place it Out-of-the-Money (OTM).

Usually, for Debit Spreads like the Bear Put Spread, the highest win rate you can achieve is a 50% win rate (without the Short Put being ITM).

This is typical for Option strategies where you’re buying premium (i.e. Calendar Spreads, Butterflies, Diagonal Spreads, etc.)

On the other hand, Optino strategies where you’re selling premium will get you a higher win rate that’s usually above 65% (i.e. Iron Condor, Strangles, Credit Spreads, Put Ratio Spreads, etc.)

### Positive Expectancy By Default

To determine whether a strategy is profitable or not, we calculate what’s called the Expectancy of the strategy.

This is the formula to calculate Expectancy:

Expectancy = (Win Rate x Average Profit) – (Loss Rate x Average Loss)

This will give us a rough indication as to how much we expect to make on average per trade.

If it’s a positive number, we call it Positive Expectancy.

If it’s a negative number, we call it Negative Expectancy.

This is the risk profile of a Bear Put Spread with an ITM Long Put and an OTM Short Put:

Generally, we want to use the average P&L when calculating Expectancy.

However, just by using the data on the risk profile and the maximum P&L, we’re able to come up with a rough Expectancy number.

So the data we will use from this risk profile is:

- Win Rate: 51.33%
- Loss Rate: 48.67%
- Max Profit: $615
- Max Loss: -$385

Just from these numbers alone, we can calculate the rough Expectancy of the Bear Put Spread as this:

Expectancy = (51.33% x $615) – (48.67% x $385) = $128.30

That means on average, we expect to make $128.30 per trade with this Bear Put Spread construct.

This is by default a Positive Expectancy.

Now, you might be wondering, what about its counterpart – The Bull Call Spread?

Does it also have a Positive Expectancy by default?

### Difference Between Bull Call Spread And Bear Put Spread

The Bull Call Spread is the bullish version of the Debit Spread.

If we were to construct it in a similar fashion as the Bear Put Spread, it would consist of an ITM Long Call and an OTM Short Call.

The risk profile would look like this:

If we were to use the same data presented in this risk profile, the Expectancy would be calculated as this:

Expectancy = (48.59% x $378) – (51.41% x $622) = -$136.10

As you can see, this is a Negative Expectancy by default.

So why is it that the Bear Put Spread is a Positive Expectancy, whereas the Bull Call Spread is a Negative Expectancy?

That’s because of skew.

More specifically, Put skew in this case.

That means that the Options are priced more expensively at the lower strike prices compared to the higher strike prices.

That’s because of the difference in Implied Volatility (IV) of the Options.

The higher the IV, the more expensive the Options are.

And the lower the IV, the more inexpensive the Options are.

Because this Bear Put Spread is constructed on the Index ETF SPY, it has Put skew which makes the lower strike prices more expensive.

In the Bear Put Spread example, it’s constructed with the:

- Long 403 Put (lower IV)
- Short 393 Put (higher IV)

So we bought the relatively cheaper Put in terms of IV, and sold the relatively more expensive Put in terms of IV.

And this resulted in a Positive Expectancy.

On the other hand, the Bull Call Spread example is constructed with the:

- Long 393 Call (higher IV)
- Short 403 Call (lower IV)

So we bought the relatively more expensive Call in terms of IV, and sold the relatively cheaper Call in terms of IV.

And this resulted in a Negative Expectancy.

However, not all stocks/ETFs have Put skew.

There are stocks with Call skews, which is the opposite of Put skew.

That means that the Options at the higher strike prices have higher IV compared to the lower strike prices.

In those stocks, the Bull Call Spread would have a Positive Expectancy and the Bear Put Spread would have a Negative Expectancy.

## Understanding the Losing Streak of Debit Spreads

The next thing to really understand about the Bear Put Spread, or any Debit Spreads in general is the losing streak that it can have.

Many times, new traders put on an Options strategy they’ve just learned and when they have two or three losses in a row, they discard the strategy claiming it doesn’t work.

However, that may be a little premature without understanding the possible losing streak that can occur.

The table above shows the probability of X consecutive losing trades within a 100-trade sequence.

And since Debit Spreads tend to have a win rate of 50%, we want to focus on the 50% row.

As you can see, it shows a 100% probability of having 4 losses in a row and a 95% probability of having 5 losses in a row.

That means that it’s very likely you will hit 4 – 5 consecutive losses at some point when trading Debit Spreads.

There’s also a 52% probability of having 7 consecutive losses, so it’s certainly possible as well.

So it’s important to understand that with premium-buying strategies, you can suffer many losses in a row, unlike premium-selling strategies.

But there’s a way to tweak the Bear Put Spread to have a slightly higher win rate.

By adjusting the strikes up and still keeping the Short Put OTM, the win rate can be tweaked to 59.47%.

And it’s still a Positive Expectancy, although it’s lesser than the original Bear Put Spread construct.

By tweaking it, you’d be able to have a small number of consecutive losses.

This can help in your psychology because the last thing you want is to have a few losers in a row and then fear putting on the next trade.

## How To Trade The Bear Put Spread

So here are 3 criteria to further put the odds in your favor when trading the Bear Put Spread:

**Criteria #1: Wait till the market is overbought (using the Stochastic Oscillator / RSI Indicator).**

There’s a higher probability of the market going down when the market is in an Overbought condition compared to an Oversold or Neutral condition.

**Criteria #2: Enter a Bear Put Spread when the price is at or near a Resistance Level (previous high).**

By placing the Bear Put Spread when the price is at or near the Resistance Level, it increases the chances of the market going down.

**Criteria #3: Adjust Spread Till You Get A 1:1 Risk-to-Reward Ratio.**

When you adjust the Bear Put Spread to the point where the risk-to-reward ratio is 1:1, because of the Put skew, the win rate becomes higher.

This way you will win more often than you lose while keeping the risk-to-reward the same.

As you can see in the trade example above, it meets all our 3 criteria:

- Stochastic Oscillator showing an overbought reading.
- Price is at a resistance level and also formed a bearish candlestick pattern.
- Constructed a Bear Put Spread with a 1:1 risk-to-reward ratio and a 58.48% win rate.

This is how to trade the Bear Put Spread.

Michael says

Are there any ETFs that mostly use bear put spreads?