What is a Covered Bear
A covered bear is a trading strategy in which a short sale is made on a long position. A bear spread is an option strategy in which the investor is aiming to achieve the maximum possible profit when the price of the underlying security drops. This can involve bear put spreads and bear call spreads. The investor would buy a contract that involves a higher strike price while simultaneously selling a contract with a lower strike price.
BREAKING DOWN Covered Bear
A covered bear is a covered strategy where the investor shorts a stock that they already own. When an investor uses this strategy, he feels that the stock is a bear stock and will decline in value. The risk involved in this strategy is limited because the investor already owns the underlying stock and can use those shares to cover.
This is in contrast to when an investor sells stock that they do not own, which is known as an uncovered bear, or also can be called a naked trade. If the investor goes with the uncovered strategy, they may be forced to borrow the stock in order to produce it for the buyer. Or they can avoid the obligation of delivery by trading in the futures market.
A bear spread strategy is one option that might be appealing to an investor who wants to minimize their risk while still staying active in the options market.
Covered Bear Considerations
Investors can also write and purchase options as a type of covered bear strategy. Covered option trades afford investors more protection than a naked trade where the investor does not own the underlying security that he is hedging against. If the price of the underlying security doesn't fall, then the investor can let the option expire.
Employing a bear spread of any type gives an investor a better chance of realizing a profit while reducing the risk of loss if the stock prices continue on a downward momentum.
Despite their potential advantages and their appeal to investor who enjoy strategic tactics, covered bear strategies, and bear spread strategies in general, are not for everyone. They have some intricate elements that can be challenging to master, especially for the new or casual investor.
Bear spreads are generally considered a more advanced, sophisticated investing strategy. For that reason, they would usually only be advised for more sophisticated, knowledgeable investors, or those who are being directed with guidance from an experienced investment advisor.