What Is a Bear Call Spread?

One of the four basic 澳洲幸运5开奖号码历史查询:vertical option spreads, a 澳洲幸运5开奖号码历史查询:bear call spread is a two-part options strategy. It involves selling a 澳洲幸运5开奖号码历史查询:call option, and collecting an upfront option premium, while simultaneously purchasing a second call option with the same expiration date but a higher 澳洲幸运5开奖号码历史查询:strike price. 

How a Bear Call Spread Works

Because the strike of the call sold, also known as the short call leg, is lower than the strike for the call purchased, also known as the long call leg, the amount of 澳洲幸运5开奖号码历史查询:option premium collected in the first leg is always ꧃greater than the cost paid in the second leg.

Since the initiation of a bear call spread garners an upfront premium, it is also known as a credit call spread or a short call spread. This strategy generates premium income based on an options trader's bearish view of a stock, index, or another financial instrument.

A bear call spread is similar to the risk-mitigation strategy of buying call options to protect a 澳洲幸运5开奖号码历史查询:short position in a stock or index. However, because the instru🐈ment sold short in a bear call spread is a call option rather than a stock, the maximum gain is restricted to the net premium received. In a short sale, the maximum profit is the difference between the price at which the short sale was effected and zero.

When to Use a Bear Call Spread

• Modest downside is expected: This strategy is ideal when the trader expects a modest downside in a stock or index. If the investor expects a large decline, the trader is better off implementing a strategy such as a 澳洲幸运5开奖号码历史查询:short sale, buying puts, or initiating a bear put spread, where the potential gains are large and not restricted to the premium.
• Volatility is high: High implied volatility translates into an increased level of premium income. So even though the short and long legs of the bear call spread offset the impact of volatility to quite an extent, the payoff for this strategy is better when volatility is high.
• Risk mitigation is required: A bear call spread caps the theoretically unlimited loss possible with the naked short sale of a call option. Selling a call imposes an obligation on the seller to deliver the underlying security at the strike price. There is a potential loss if the underlying security soars by two or ten times before the call expires. The long leg in a bear call spread reduces the net premium that can be earned by the call writer, but the mitigation of risk justifies the cost. 

Bear Call Spread Calculations

• Maximum loss = Difference between strike prices of calls, that is, the strike price of a long call less the strike price of a short call – Net Premium or Credit Received + Commissions paid.
• Maximum Gain = Net Premium or Credit Received – Commissions paid.
• Break-even = Strike price of the short call + Net Premium or Credit Received.
  

Example

Skyhigh Inc. claims to have invented a revolutionary additive for jet fuel, and its stock has recently reached a record high of $200. Legendary options trader "Bob" is bearish, and although he thinks the stock will fall, he believes it will only drift lower initially. Bob wants to capitalize on Skyhigh's volatility to earn premium income but is concerned about the risk of the stock surging higher.

Bob initiates a bear c꧃all spread on Skyhigh as follows:

1. Sell five contracts of $200 Skyhigh calls expiring in one month and trading at $17.
2. Buy five contracts of $210 Skyhigh calls, expiring in one month and trading at $12. 
3. Because each option contract represents 100 shares, Bob's net premium income is $2,500, or ($17 x 100 x 5) – ($12 x 100 x 5) = $2,500

Consider the possible scenarios within one month💧, in the final minutes of trading on the option expiration date:

Scenario 1

Bob's view proves correct, and Skyhigh is trading at $195. In this case, the $200 and $210 calls are both out of the money and will expire worthless. Bob gets to keep the $2,500 net premium, less commissions. A scenario where the stock trades below the strike price of the short call leg is the best pos♛sible one for a bear call spread.

Scenario 2

Skyhigh is trading at $205. In this case, the $200 call is 澳洲幸运5开奖号码历史查询:in the money𒁏 by $5 (trading at $5), while the $ꦕ210 call is out of the money and, therefore, worthless.

Bob, therefore, has two choices: (A) close the 🍰short call leg at $5, or (B) buy the stock in the market at $205 to fulfill the obligation arising from the exercise of the short call. Option A is preferable since Option B would incur additional commissions to buy and deliver the stock.

Closing the short call leg at $5 would entail an outlay of $2,500 ($5 x 5 contracts x 100 shares per contract). Because🀅 Bob received a net credit of $2,500 upon initiation of the bear call spread, the overall return is $0. Bob breaks even on the trade but is out of pocket to the extent of the commissions paid.

Scenario 3

Skyhigh’s jet-fuel claims have been validated, and the stock is trading at $300. In this case🧜, the $200 call is in the money by $100, while the $210 call is in the money by $90.

However, since Bob has a short position on the $200 call and a long position on the $210 call, the net loss on his bear call spread [($100 – $90) x 5 x 100] = $5,000. But since Bob had received $2,500 upon initiation of the bear call spread, the net loss = $2,500 – $5,000 = -$2,500, plus commissions.

In this scenario, instead of a bear call spread, if Bob had sold five of the $200 calls (without buying the $210 calls), his loss when Skyhigh was trading at $300 would be $100 x 5 x 100 = $50,000. Bob would have incurred a similar loss if he had sold short 500 shares of Skyhigh at $200 without buying any call options for risk mitigation.

The Bottom Line

The bear call spread is a suitable options strategy for generating premium income during volatile times. However, gains are lim𒉰ited in this options strategy and may not justify the risk of loss if the bear call spread does not work.