What is a Bear Call Spread
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 price of the underlying asset. A bear call spread is achieved by purchasing call options at a specific strike price while also selling the same number of calls with the same expiration date, but at a lower strike price. The maximum profit to be gained using this strategy is equal to the credit received when initiating the trade.
Also called a short call spread.
BREAKING DOWN Bear Call Spread
For example, let's assume that a stock is trading at $30. An options trader can use a bear call spread by purchasing one call option contract with a strike price of $35 for $0.50 and a cost of $50 ($0.50 * 100 shares/contract) and selling one call option contract with a strike price of $30 for $2.50 or $250 ($2.50 * 100 shares/contract). In this case, the investor will earn a credit of $200 to set up this strategy ($250 - $50). If the price of the underlying asset closes below $30 upon expiration, then the investor will realize a total profit of $200 (($250 - $50) - ($35 - $30 * 100 shares/contract)).
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. Selling a stock short theoretically 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 date and the expiration date then a bear call spread could be an ideal play. However, if the underlying stock or security falls by a greater amount then the trader gives up the ability to claim that additional profit. It is a tradeoff between risk and potential reward that is appealing to many traders.
With the example above, 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 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, $35, 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 = $300 (the $500 spread between the strike prices minus the initial credit)