|
Advanced Strategies for Options -
Vertical Spreads - Bear Call Spread
Like
a bull spread, the bear spread is a vertical spread, that is, the
investor is spreading strike price levels. Bear spreads achieve their maximum profit when the
underlying stock falls in price. Also like the bull spread a bear spread has limited profit
and loss potential. However,
unlike the bull spread bear spreads are always established for a
credit since the investor is selling a call with a lower strike
price and buying a call with a higher strike price. The call with the lower strike price always trades at a
higher price.
Why
would an investor establish a bear spread? Because bear spreads offer limited risk they are commonly
used by investors who are bearish but do not want to assume the
unlimited liability associated with short sales.
Consider
this example; Cisco Systems (CSCO) common stock is trading at $100
per share. Maria
believes CSCO shares will fall in price but she is uncomfortable
establishing an outright short sale. She decides to establish a bear spread by selling one
contract of the CSCO December 100 call for $5 and buying one
contract CSCO December 105 call for $1.50.
In
this case Maria receives a net credit of $3.50 per contract or
$350. The best case
scenario would be for CSCO shares to decline below $100. If that were to occur Maria would keep the entire premium
but let’s examine what happens if CSCO rises in price.
|
Cisco
Systems Share Price at Expiration
|
Profit
for December 100 calls
|
Profit
for December 105 calls
|
Total
Profit
|
|
100
|
$500
|
($150)
|
$350
|
|
102
|
$300
|
($150)
|
$150
|
|
103.50
|
$150
|
($150)
|
$0
|
|
105
|
$0
|
($150)
|
($150)
|
|
106.50
|
($150)
|
$0
|
($150)
|
|
108
|
($300)
|
$150
|
($150)
|
|
109.50
|
($450)
|
$300
|
($150)
|
As
we can see if the spread expands in price Maria begins to lose
money. Her loss is
limited to $150, the difference between the strike prices less the
credit received for the bear spread. Her potential profit is also
limited. Maria
achieves her maximum profit if CSCO shares decline to $100 or
lower. In this case
she keeps the entire premium from the 100 call and her long 105
call expires worthless. Maria’s
break-even point occurs if CSCO rallies to $103.50. In this case Maria gains $150 on the short 100 calls and
loses $150 on the long 105 calls.
Summary
1. Bear spreads are a bearish strategy always established for
a credit.
2. The break-even point of a bear spread is equal to the lower
strike price plus the amount of the credit received.
3. The maximum profit is limited to the net credit received.
4. The maximum risk is the difference between the strike
prices less the net credit received.
5. In some cases a bear spread using calls may require a small
margin requirement because the short call is not “covered” by
a long call with a strike price equal to or lower.
bull
put spread 
bear put spread
|
Home > Education > Using Options > Advanced Strategies >
Vertical
Spreads > Bear Call Spread
