Bear Call Spread: Definition, Implementation, And Profit

What Is A Bear Call Spread?

A bear call spread is a vertical spread options strategy, which involves two call options with the same expiration date but different strike prices. This strategy is used when the options trader is bearish on the market. To employ this options strategy the trader sells an at-the-money call option and buys an out-of-the-money call option simultaneously of the same expiration date.

Construction of Bear Call Spread Options Strategy

To employ this strategy you need to follow these step;

  1. Buy an out-of-the-money call option.
  2. Sell an At-the-money call option.

Understanding The Bear Call Spread Options Strategy

A bear call spread is like a risk-mitigation strategy, where the long position in call option that protects against a short call option position in a stock or index. Since there is both a short and long position in the call options of a particular underlying stock or index the maximum profit and loss are limited.

This strategy is perfect when the trader is moderately bearish in an underlying stock or index, and rather than a big fall. Because if the expectation is for a huge decline, the trader should go for a long put or directly short the underlying stock or index in the future where the trader will realize a huge profit.

When the implied volatility of the market is high then the premium of the call options increase and the net payoff in this strategy also increases. So this strategy is also good in a volatile market.

Bear Call Spread Options Strategy Profit and Loss

bear call spread diagram

Maximum Profit

The maximum profit in this strategy occurs when the stock price closes below the strike price of the short call option at the expiration date where both options would expire worthlessly and the net profit would be the difference between the short call and long call option.

  • Maximum Profit = Net Premium Received – Charges Paid

Maximum Loss

If the underlying stock or index price rises above the strike price of the long call option at the expiration date, then the bear call spread options strategy will suffer a maximum loss equals to the difference in the strike price between the two call options minus the premium received while selling the call option.

  • Maximum Loss = Strike Price of Long Call option – Strike Price of Short Call option – Net Premium Received + Charges Paid

Breakeven

  • Breakeven Price = Strike Price of Short Call Option + Net Premium Received

Using the above formula you can calculate the breakeven price for the strategy.

Example

Suppose there is a stock trading at $200 in Oct contract and the trader has a bearish view on the stock, so to employ the bear call spread options strategy the trader need to short a $200 call option, for example, that is trading at $6 and goes long in the $210 call option trading at $2.

If the stock expires at or below $200 level then the options trader will book a net profit of $400, as both the call options become worthless. So, $6 – $2 = $4 x 100 (contract size) = $400.

In another case, if the stock expires at $220 the $200 strike call option will become $20 where the trader will incur a loss of  $20 – $6 = $14 and the $210 call option will become $10 where the trader will make a profit of $8. So the net loss would be $14 – $8 = $6 x 100 = $600.

So in this example,

Maximum Profit = $4 x 100 = $400

Maximum Loss = $210 – $200 – $4 = $6 x 100 = $600

Breakeven price = $200 + $4 = $204

Limitations of Bear Call Spread

The only limitation of the bear call spread options strategy is that the maximum profit in this strategy is lower than the maximum loss, in most of the scenarios.

Key Takeaways

  • The maximum profit in bear call spread options strategy is limited to the premium received by the trader.
  • The maximum loss in this strategy is also limited.
  • Maximum profit achieved when the price of the underlying stock or index is less than or equal to the strike price of short call option.
  • The maximum loss in this strategy incurred when the price of the underlying stock or index is greater than the strike price of the long call option.

Conclusion

The bear call spread is one of the most used options strategies, generally used in indices, and trader with a little bit of experience can easily employ this strategy. As the strategy is limited profit and limited loss, chances of getting huge loss in impossible. Using this strategy one can build a complicated options strategy like the iron butterfly.

Video Source: Projectoption

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