Friday, December 15

Bear Call Spread

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The bear call spread strategy is used when we thinks that the price of underlying asset will go down moderately in near term. If you think the price will go down a lot, I suggest don’t use this strategy. There are better strategy for that condition. It is implemented by selling an in-the-money (ITM) call option (has higher price) and buying an out-of-the-money (OTM) call option (has lower price) on the same underlying stock with the same expiration date. bear call spread has limited profit and risk. This type of strategy is known as credit spread where you will get income when entering the position. The amount received by selling higher strike call option is higher than the cost of purchasing call with lower strike.

To understand better, here’s an example. Stock XYZ is trading at $40, and we think it is going to drop soon moderately, so we enter a bear call spread by buying a September 45 call for $100 and writes a September 35 call for $300. Thus, we receives a net credit of $200 when entering this position. If XYZ begins to drop and closes at $34 on expiration date, both options expire worthless and we keep the entire credit of $200 as profit. This is the maximum profit you can get. If XYZ goes up to $46, both options expire in-the-money. The September 35 call will have an intrinsic value of $700 and the September 45 call will have an intrinsic value of $200. This means that the position is now worth $500 at expiration or $500 loss. Since we had received a credit of $200 when entered the spread, our net loss comes to $300. This is the maximum loss you can have. The above example did not take commission charges for easy understanding. But you must know the profit and loss also depends on the commision from your brokerage.

Learn more about bull put spread and other option strategy

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