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Bear Call Spread
The bear call spread is employed when the options trader thinks that the price of the underlying asset will go down moderately in the near term. A credit is received upon entering the trade, making this a credit spread strategy.
| Bear Call Spread Construction |
| Buy 1 OTM Call Sell 1 ITM Call |
The bear call spread strategy requires the options trader to buy call options of a certain strike price and sell the same number of call options of lower strike price on the same underlying security expiring in the same month.
Limited Downside Profit
The maximum gain attainable using the bear call spread strategy is the credit taken in on entering the trade. To reach the maximum profit, the stock price needs to close below the strike price of the lower striking call sold at expiration date where both options would expire worthless.
The formula for calculating maximum profit is given below:
- Max Profit = Net Premium Received - Commissions Paid
- Max Profit Achieved When Price of Underlying <= Strike Price of Short Call
Limited Upside Risk
If the stock price rise above the strike price of the higher strike call at the expiration date, then the bear call spread suffers a maximum loss equals to the difference in strike price between the two options minus the original credit taken in when entering the position.
The formula for calculating maximum loss is given below:
- Max Loss = Strike Price of Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid
- Max Loss Occurs When Price of Underlying >= Strike Price of Long Call
Breakeven Point(s)
The underlier price at which break-even is achieved for the bear call spread can be calculated using the following formula.
- Breakeven Point = Strike Price of Short Call + Net Premium Received
Example
Suppose XYZ stock is trading at $37 in June. An options trader bearish on XYZ decides to enter a bear call spread position by buying a JUL 40 call for $100 and selling a JUL 35 call for $300 at the same time, giving him a net $200 credit for entering this trade.
The price of XYZ stock subsequently drops to $34 at expiration. As both options expire worthless, the options trader gets to keep the entire credit of $200 as profit.
If the stock had rallied to $42 instead, both calls will expire in-the-money with the JUL 40 call bought having $200 in intrinsic value and the JUL 35 call sold having $700 in intrinsic value. The spread would then have a net value of $500 (the difference in strike price). Since the trader have to buy back the spread for $500, this means that he will have a net loss of $300 after deducting the $200 credit he earned when he put on the spread position.
Aggressive Bear Call Spread
One can enter a more aggressive bear spread position by widening the difference between the strike price of the two call options. However, this will also mean that the stock price must move downwards by a greater degree for the trader to realise the maximum profit.
Bear Spread on a Debit
The bear call spread is a credit spread as the difference between the sale and purchase of the two options results in a net credit. For a bearish spread position that is entered with a net debit, see bear put spread.