Bear Call Spread

 

Description

 

The Bear Call Spread is an intermediate strategy that can be profitable for stocks that are either rangebound or falling. The concept is to protect the downside of a Naked Call by buying a higher strike call to insure the one you sold.

Both call strikes should be higher than the current stock price so as to ensure a profit even if the stock doesn’t move at all. The higher strike call that you buy is further out-of-the-money than the lower strike call that you sell. Therefore, you receive a net credit because you buy a cheaper option than the one you sell, thereby highlighting that options are cheaper the further out-of-the-money you go.

If the stock falls, both calls will expire worthless, and you simply retain the net credit. If the stock rises, then your break even is the lower strike plus the net credit you receive. Provided the stock remains below that level, then you’ll make a profit. Otherwise you could make a loss. Your maximum loss is the difference in strikes less the net credit received.

Market Opinion

Bearish.

P/L

 

 

 

When To Use

This strategy is used if you are bearish and want to reduce your maximum risk while at the same time generating income from the sold calls.

Example

XXXX is trading at $28 on May 10, 2011.

Sell the June 2011 30 strike call for $1.00.

Buy the June 2011 35 strike call for $0.50.

Benefit

The benefit to this strategy is that it is short term where you can make income while capping the downside.

Risk vs. Reward

The risk is the difference between the strike prices less the net credit received. The reward is the net credit of the sold calls minus the bought calls.

Net Upside

Net credit received.

Net Downside

The difference in strikes minus net credit.

Break Even Point

Lower strike plus net credit.

Effect Of Volatility

N/A

Effect Of Time Decay

Positive when the position is profitable. Negative when in a losing position, because the closer to expiration the closer you are to making your maximum los.

Alternatives Before Expiration

If your stock rises above the stop loss you can buy back the short call or close out the whole position.

Alternatives After Expiration

Close the position. Buy back the calls sold and sell the calls bought.