Bear Call Spread Strategy

“A bear call spread is a limited risk/limited reward play”

This option strategy is 1 of 4 variations to the vertical spread strategy.

Overview/General Remarks

In my opinion, bear call spreads are the most overused of the four vertical spreads.

Why?

Because at any given time someone somewhere is preaching how bad everything is and that a market crash is imminent. While this may be true, it may not and likely will not happen when everyone expects it. The market has a nasty habit of doing just the opposite of what’s expected. That said, when it does tank those folks will have the pleasure of saying, “I told you so”. Until then, don’t let it affect your trading.

One more note…these talking heads often show themselves right after a slight downtrend, suggesting here comes the end of life as we know it. Please don’t follow the hype, more often than not you’ll either be privy to the fact our economy is tanking or the asset(s) will rebound. For more on why I believe in the rebound check out my bull put strategy overview here.

Of course, this is just my opinion. Freely generate your own and maybe share it in the comments at the end of this page for everyone.

Expectations

A bear call strategy expects the stock price to decrease or remain neutral. Furthermore, the risks and rewards are limited and clearly identified upon entering the trade.

Much like the bull put spread, the bear call benefits from time decay. Additionally, look to enter this position in during periods of relatively high volatility.

Setup/Construction

Setting up a short vertical call spread consists of selling a short call option at a lower strike and simultaneously buying a call option at a higher strike.

Example Bear Call Spread

Example trade on SPY etf. Click to Enlarge.

Bear Call Spread Example

Reward/Loss

Max reward is the credit received = $.57 or $57
Max loss is the strike width minus credit = $1 – $.57 =$.43 or $43

The horizontal sections of the P/L diagram indicate the max profit and max loss. Therefore, the point at which the blue line crosses zero highlights the break even point for this example.

Price assumptions

Price will remain at or below the current level.

Key Benefits of the Bear Call Spread

– Hedged

– Minimal risk

– Time decay

– Profit from both stagnant and declining prices.

“The Greeks”

Remember this is a multiple contract strategy so be sure to look at the net Greek position. For a recap of the Greeks visit the terms page here.

Volatility

IV = 13.67%
IV rank = Less than 1%
Selling the bear call spread in these market conditions is NOT preferred.

When volatility is low net buying is the better play. Net buyers benefit from rising volatility while net sellers benefit from falling volatility.

Liquidity

SPY is very liquid. However, be sure to check open interest, volume, and the bid/ask spread of any desired asset before initiating a position.

Probability ITM/OTM

As a net seller, the desired outcome is to have the spread finish OTM. Thus, the trader keeps the entire credit received at entry.

Final Thoughts

I often use the bear call spread strategy in my own trading. Time decay is beneficial and profit is generated from both stagnant or declining markets.

With regard to this example, I like the risk/reward payoff of $57/$43. I also like the favorable OTM probability but I DON’T like the current volatility conditions, because of this I would move away from this trade. However, when volatility becomes difficult to find a complete breakdown of the pros/cons will help to determine trade viability.

Have questions about the bear call spread. Ask me in the comments.

Disclaimer

U.S. Government Required Disclaimer: Options trading products, services, and information are for educational purposes only. All information shared is confidential and proprietary. As such, your success with this content is entirely dependent upon your actions. You are required to do you own research and due diligence. Options trading products and training programs are for educational purposes only, and are provided with the understanding that I’m not a registered investment adviser and nothing herein shall be construed as a solicitation and/or recommendation to buy, sell, or hold any financial instruments.

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