The bear call spread is a vertical spread 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.

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.

Profit/Loss

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

The max loss can be calculated by taking the difference between the two strike prices minus the premium received. This is reached when the strike finishes over the higher strike price at expiration.

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 going lower, but not sure on their timing or wants to giving themselves a cushion in case the market moves sideways or trades up slightly.

 

Other Articles You May Be Interested In

ChrisDouthit
ChrisDouthit

The founder of OptionStrateigesInsider.com has a long history with options and an extensive education in finance. Holding an MBA and multiple finance degrees, Chris has put in the time and effort to learning the market fundamentals.