The bear call spread is a vertical spread options strategy where the investor sells a lower strike price call option, represented by point A, and buys a higher strike price call option, point B, within the same expiration month. The investor will receive a premium or credit, as the lower strike price call will have more value than the higher call. An investor entering this trade has a potential profit that is limited to the premium they received when they executed the trade and a potential loss once the stock raises above their short strike price in an amount larger than the premium they received.

bear call spread

The investor uses this strategy if they believe the market will stay flat or trade lower. The higher call is used as a hedge in case the market does trade higher, so the investor can cap their max loss.

The Bear Call Spread Strategy

The bear call spread is an options strategy that works by letting the options decay slowly day after day until the expiration date, resulting in both options expiring worthless and the investor and keeping the entire premium. It is best to apply the strategy when it’s expected that a stock will likely trade sideways or drop in price.

This strategy tends to be a favorite among many traders and is suitable for all investors, as it allows them to apply a high probability trade with limited risk. It is best to apply once the stock is already had a sharp move higher and is overbought or if the stock is expected to break down.

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It is best to apply the vertical call spread when implied volatility is high, which increases the option pricing, allowing the trader to receive a higher premium on the trade.

Profit/Loss

The most an investor can expect to make on this trade is the credit or premium they received. If the stock finishes below the lower strike price at expiration, the investor will achieve maximum profit.

The maximum loss can be calculated by taking the difference between the two strike prices minus the premium received. This is reached when the stock price finishes over the higher strike price on the expiration date. Generally, if short calls go into the money, the trader will most likely be assigned the stock position at expiration. However, when calls go deep into the money, there is always a risk of early assignment.

Breakeven

The breakeven for a bear call spread is the lower strike price plus the cost of the trade.

Breakeven = short call strike + premium received

Example

A 55-60 call spread valued at $2 would consist of selling a 55-strike price call and buying a 60 strike price call. Here the $2 premium would represent the max win if the stock stayed below the 55 strike price. Having a $5 wide strike width (60 -55), representing the max loss if the trade finishes above both strike prices, minus the premium received to get into the trade, in our example $2, leaving the investor with a max loss of $3.

Time decay is working for the investor if the call spread is out of the money because they want the trade to expire, allowing them to keep the full premium received.  Time will be working against the investor if the vertical has both strikes in the money because they would want this trade to continue, giving them more time for the stock to drop in price.

Conclusion

This is a great strategy to use if the investor feels a stock is moving sideways lower, but not sure on their timing or wants to giving themselves a cushion in case the market moves sideways or trades up slightly.

Many traders flocked to the bear call spread due to its high probability of success and limited risk, but if the stock does move against a trader, it can cost them far more than their initial investment. For those looking to execute a spread with a lower probability of success, but a much lower potential loss, they should consider the bear put spread or the bull call spread.

 


Chris Douthit
Chris Douthit

Chris Douthit, MBA, CSPO, is a former professional trader for Goldman Sachs and the founder of OptionStrategiesInsider.com. His work, market predictions, and options strategies approach has been featured on NASDAQ, Seeking Alpha, Marketplace, and Hackernoon.