Bear Call Spread

Bear Call Spread

Post By - Laxmi Mahera
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Bear Call Spread

Description - Bear Call Spread

The Bear Call Spread is an intermediate strategy that can be profitable for stocks that are either range bound or falling.
The concept is to protect the downside of a Naked Call by buying a higher strike call to insure the one you sold.
Both call strikes should be higher than the current stock price so as to ensure a profit even if the stock doesn’t move at all.
The higher strike call that you buy is further OTM than the lower strike call that you sell
If the stock falls, both calls will expire worthless, and you simply retain the net credit.
If the stock rises, then your breakeven is the lower strike plus the net credit you receive.
Provided the stock remains below that level, then you’ll make a profit.
Otherwise you could make a loss. Your maximum loss is the difference in strikes less the net credit received.

Context - Bear Call Spread

Outlook

With bear calls, your outlook is bearish or neutral to bearish.

Rationale

To execute a bearish income trade for a net credit while reducing your maximum risk.
The bought calls will have the effect of limiting your risk, while the sold calls produce the income element.

Net Position

This is a net credit trade because your bought calls will be cheaper than your sold calls, which are further out of the money.

Effect of Time Decay

Time decay is helpful to this position when it is profitable and harmful when it is loss-making.

Time Period to Trade

It’s safest to trade this strategy on a short-term basis, preferably with one month or less to expiration
Remember, if you’re buying and selling OTM options to make a net credit, you’ll make a profit if the stock doesn’t move.

Breakeven = (Lower strike + net credit)

Steps to Trading a Bear Call Spread

Steps In

Try to ensure that the trend is downward or rangebound and identify a clear area of resistance.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
If the stock rises above your stop loss, then buy back the short call or unravel the entire position.
If the stock remains below the lower strike call, the options will expire worthless, and you’ll retain the net credit.

Exiting the Trade - Bear Call Spread

Exiting the Position

With this strategy, you can simply unravel the spread by buying back the calls you sold and selling the calls you bought in the first place.

Mitigating a Loss

Unravel the trade as described previously.
Advanced traders may choose to only partially unravel the spread leg-by-leg.
In this way, they will leave one leg of the spread exposed in order to attempt to profit from it.

Advantages and Disadvantages

Advantages

Short-term income strategy not necessarily requiring any movement of the stock.
Capped downside protection compared to a Naked Call.

Disadvantages

Maximum loss is typically greater than the maximum gain, despite the capped downside.
High yielding trades tend to mean less protective cushion and are therefore riskier.
Capped upside if the stock falls.

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