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
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.
XXXX is trading at $28 on May 10, 2011.
Sell the June 2011 30 strike call for
Buy the June 2011 35 strike call for $0.50.
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 credit received.
The difference in strikes minus net credit.
Break Even Point
Lower strike plus net credit.
Effect Of Volatility
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
the position. Buy back the calls sold and sell the calls bought.