Bear Call Spread: Overview and Examples of the Option Strategy
A bear call spread, or a bear call credit spread, is a type of options strategy used when an options trader expects a decline in the underlying asset’s price. By simultaneously selling a call option and buying a call option with the same expiration date but a higher strike price, one can create a bear call spread. This strategy’s maximum profit equals the credit received when initiating the trade.
A bear call spread is also called a short call spread. It is considered a limited-risk and limited-reward strategy.
Advantages of a Bear Call Spread
The main advantage of a bear call spread is that the net risk of the trade is reduced. Purchasing the call option with the higher strike price helps offset the risk of selling the call option with the lower strike price. It carries far less risk than shorting the stock or security since the maximum loss is the difference between the two strikes reduced by the amount received or credited when the trade is initiated. Theoretically, selling a stock short has unlimited risk if the stock moves higher.
If the trader believes the underlying stock or security will fall by a limited amount between the trade and expiration dates, then a bear call spread could be an ideal play. However, if the underlying stock or security falls by a more significant amount, the trader gives up the ability to claim that additional profit. A trade-off between risk and potential reward is appealing to many traders.
Example of a Bear Call Spread
Let’s assume that a stock is trading at $45. An options trader can use a bear call spread by purchasing one call option contract with a strike price of $40 and a cost/premium of $0.50 ($0.50 * 100 shares/contract = $50 premium) and selling one call option contract with a strike price of $30 for $2.50 ($2.50 * 100 shares/contract = $250).
In this case, the investor will receive a net credit of $200 to set up this strategy ($250 – $50). If the underlying asset’s price closes below $30 upon expiration, the invisible realizess a total profit of $200, or the entire premium received.
Therefore, the profit from the bear call spread maxes out if the underlying security closes at $30—the lower strike price—at expiration. If it closes further below $30, there will not be any additional profit. If it closes between the two strike prices, there will be a reduced profit, while closing above the higher strike, $40, will result in a loss of the difference between the two strike prices, reduced by the amount of the credit received at the onset.
- Max profit = $200 (the credit)
- Max loss = $800 (the 10 points between the spread strikes x100, minus the initial credit received)
Conclusion
- To create a bear call spread, buy two call options—one long and one short—with different strike prices but the same expiration date.
- Bear call spreads are considered limited risk and reward because traders can use this strategy to reduce their losses or realize reduced profits. The strike prices of their call options set the limits of their profits and losses.
