What is a Bear Spread
A bear spread is an option strategy that will profit when the price of the underlying security declines. The strategy involves the simultaneous purchase and sale of options, where either puts or calls can be used. A trader buying a put bear spread would purchase a put with a higher strike price while simultaneously selling a put with a lower strike price. Likewise, a trader can sell a call with a lower strike price and buy a call with a higher strike price. The options will often have the same expiration date. A bear spread is sometimes called a bear vertical spread, and is in contrast to a bull vertical spread.
Bear spreads can also involve ratios, such as buying one put to sell two or more puts at a lower strike price than the first. Because it is a spread strategy that pays off when the underlying declines, it will lose if the market rises - however, the loss will be capped at the premium paid for the spread.
BREAKING DOWN Bear Spread
A bear spread is also a trading strategy used by futures traders who intend to profit from the decline in commodity prices while limiting potentially damaging losses. In an options bear spread, the options position makes money if the underlying security goes down, and loses if the underlying security rises in price. A futures bear spread is created through the simultaneous purchase and sale of two of the same or closely related futures contracts. This is accomplished in the agricultural commodity markets by selling a future and offsetting it by purchasing a similar contract with an extended delivery date.
Bear Put Spread Example
Assume an investor is bearish on stock XYZ when it is trading at $50 per share and believes the stock price will decrease over the next week. The investor purchases 10 put options with a strike price of $55 and writes 10 put options with a strike price of $45, which expire the next week, for a combined total of $3,500. Therefore, the investor's maximum loss is the amount paid to implement the position, and the maximum profit is limited to the strike price of the long put less the strike price of the short put and the net premium paid. Assuming options have a contract size of 100, the maximum profit of the position is $6,500, or ($55 * 10 * 100) - ($45 * 10 * 100) - $3,500. In this bear put spread, the maximum profit is achieved if stock XYZ trades below the strike price of the short put, or $45. The break-even point of a bear put spread is equivalent to the strike price of the long put option less the net premium paid.
Futures Bear Spread
Assume an investor is bearish on the Standard & Poor's 500 Index (S&P 500) when it traded at 2,000. The investor believes the S&P 500 will fall in the short term but rebound over the long term. Therefore, the investor creates a bear spread by selling short one S&P 500 futures contract expiring in six months for 1,995, and simultaneously purchases one S&P 500 futures contract expiring the next year for 1,997.