A Bear Call spread is a credit spread created by purchasing a higher strike call and selling a lower strike call with the same expiration dates. This strategy is best implemented in a reasonably bearish market when you think that the stock will go down. The profit on this strategy can increase by as much as 1 point for each 1 - point decrease in the price of the underlying stock. It’s a superb strategy to use in the last 30 days of on options life on volatile options, as a credit spread has time erosion on its side. The strategy has both limited profit potential and limited downside risk.

Steps to Using a Bear Call Spread.

Step 1. Research:

Look for a moderately bearish market where you anticipate a modest decrease in the price of the underlying stock – not a large move.
Check to see if this stock has options that are liquid with a high open interest or (OI).
Review the call options premiums as per the expiration dates and strike prices, and find the option combinations that turn out a high net credit.

Step 2. Analyse:

Here you don’t own the stock; your rationale is to anticipate the stock remains above your set price level.
Investigate implied volatility values to see if the options are overpriced or undervalued.
Explore past price trends and liquidity by reviewing price and volume charts over the last year. Utilise all your technical indicators on the stock to ascertain a definite market direction.

Step 3. Establish a Strategy:

Choose a higher strike call to buy and a lower strike call to sell with the same expiration date. Remember to keep the time frame as short as possible on the option, so that the stock will be more predictable with its movement as to avoid assignment of the stock. Avoid selling in-the-money options unless you want to own the stock for future trading.

Step 4. Profits vs. Risk Potential:

To calculate our risk vs. reward ratio we must look at the different spreads available to us.

1. Calculate the maximum possible reward by calculating the difference between the long call premium minus the short call premium x the option contract ratio (100 /1000). The sum of difference between the two strike premiums equals the net credit received.

2. Analyse the maximum possible risk by computing the difference between the strike prices and subtracting the net credit received, and then multiply this by the option contract ratio 100 /1000.

3. Calculate the break even on the trade by adding the net credit to the short or lower strike price.

4. The return on investment is worked out by analysing the potential reward as opposed to the possible risk on the trade.

Step 5. Risk Profile:

Create a risk profile for the trade to graphically determine the trade’s feasibility. A bear call spread will show a limited profit above the breakeven price as well as a limited loss below the breakeven price. You can see this profile on the ShareChart profile example shown below.



Write down the trade in your trader’s journal before placing the trade with your broker to minimize mistakes made in placing the order and to keep a record of the trade.


Step 6. Carry out your Plan:

Contact your broker to buy and sell the chosen call options making sure that your broker places the trade as a limit order and steps both legs (long and short) of the trade in at the same time.
Watch the market closely as it fluctuates. The profit on this strategy is limited – a loss occurs if the underlying stock rises to or above the higher strike price, the maximum lose occurs.


Step 7. To Exit the Trade:

Choose an exit strategy based on the movement of the underlying stock and the changes in implied volatility of the option price. There are a number of different strategies that can be applied to bear call spreads when it comes time to exit the trade.

These strategies are outlined over the page to give the spread trader a full understanding of the different choices that one can make when it comes to exiting a spread.

A. If the underlying stock falls below the short call or lower strike price: Let both options expire worthless to make the maximum profit which in this case is the initial credit received at the opening of the trade.

B. If the underlying stock falls below the breakeven price, but not as low as the short or lower strike price: Buy back the short call to avoid assignment. If the short call is assigned, you are then obligated to deliver 100 /1000 shares of the underlying stock at the short or lower strike price. If you don’t already own the shares then you will have to buy them at market value. This loss is partially balanced out by the initial credit received. To bring in additional money, sell the long call.

C. If the underlying stock remains above the breakeven, but stays below the long or higher strike price: Buy back the short call to avoid assignment. If the short call is exercised and assigned to you, then you are obligated to deliver 100 /1000 shares of the underlying stock at the short or lower strike price. If you don’t already own the shares then you will have to buy them at market value. This loss is partially balanced out by the initial credit received. To bring in additional money, sell the long call.

D. If the underlying stock rises above the long or higher strike price: Buy back the short call to avoid assignment. If the short call is exercised and assigned to you, then you are obligated to deliver 100 /1000 shares of the underlying stock at the short or lower strike price. By exercising the long call option, you can turn around and buy the shares at the long call or higher strike price regardless of how high the stock has risen. This limits your loss to the maximum of the trade. The loss is partially offset by the initial credit received at the opening of the trade.

General Exit Position Rules:

To exit the trade, you need to buy the short or lower strike call back and sell the long or higher strike call or for the highest profit simply let the options expire worthless.

If and when the short call is exercised by the assigned option holder, your long call will be exercised immediately to cover the short position, leaving you with a potential maximum loss calculated in setting up the spread.

Maximum profit occurs when the price of the stock stays below the short or lower call strike price.