A trading strategy known as a bull put spread offers the benefits of put-selling while taking on less risk.#-ad_banner-#

To initiate a bull put spread, the trader sells a put option and simultaneously purchases another put option on the same underlying asset with the same expiration date but a lower strike price. A net credit is collected, and while you generate less income than you would by selling a put alone, the purchased put acts as insurance against big losses.

Today, I want to look at a specific bull put spread trade in Micron Technology (Nasdaq: MU).

Because we may be obligated to buy shares of the underlying stock with this strategy, it is important that we be willing to own the shares at the strike price of the put being sold. Therefore, I’ll take a moment to discuss why I am bullish on MU.

Micron Technology manufactures semiconductors, memory chips, various flash memory drives and other related products worldwide that are used in smartphones, solid-state drives, tablets and computers, as well as in other industrial and automotive applications.

From a technical point of view, MU is in a long uptrend. 

It has a relative strength (RS) rank of 96, meaning it has outperformed 96% of all other stocks in the past 12 months. It has been proven that stocks with high RS are more likely to continue outperforming.

MU sold off 3% on news this week that another company had overtaken it as the world’s #2 dynamic random access memory (DRAM) chip producer. According to market research firm DRAMeXchange, South Korea’s SK Hynix garnered 28.2% market share during the first quarter, edging out Micron’s 28%.

I’m not worried about Micron coming in third, and we can use this volatility to our advantage as it is driving up option premiums. MU has solid support around $21, and I would be comfortable owning shares at this level, which is about 22% below recent prices.

As I mentioned above, we’ll be initiating a bull put spread in which we will be net option sellers, generating a net credit on the transaction while defining our risk upfront.

Action to Take –>
— Sell to Open (STO) MU Oct 21 Put
— Buy to Open (BTO) MU Oct 19 Put
— Net Credit: $0.30 or better Good Till Canceled (GTC)

If MU is below $21 when the puts expire Oct. 17, we will be obligated to buy 100 shares per contract at $21 per share. But because we received $0.30 per share in advance as premium from the credit spread, the net cost per share will be $20.70 (not including commissions). 

But here is the kicker: We cannot lose more than $1.70 per share ($170 per contract) on this trade, no matter what happens. That’s because, with a bull put spread, the maximum loss is the difference between the two strike prices minus the net credit. 

If MU is between $21 and $19 at expiration, we would be in the same position as if we had just sold a put, and we will take ownership of shares at a net cost of $20.70. However, if MU falls below $19, the gains from the long put would offset the losses in our assigned position.

If we only sold a naked October $21 put on MU, we would receive more premium (about $0.75 as of this writing), but we would take on more risk. We would incur a loss at any price below our break-even price of $20.25 per share ($21 strike minus $0.75 in premium) in this example. So, with the suggested bull put spread above, we are sacrificing $0.45 per share ($45 per contract) in income — but reducing our risk substantially. 

If MU stays above the $21 short put strike price through Oct. 17, both options will expire worthless, leaving us with the $30 in premium, which represents an 18% return on our risk capital of $170 in 156 days.

This article was originally published at ProfitableTrading.com: 
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