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A Bear Call Spread is used when you have a neutral to negative view on a stock.

While this strategy has a limited risk, it also has a limited reward.

So if you're expecting a big down move to occur, you'd be better off looking at a more aggressive bearish strategy that affords unlimited profit potential.

But for this strategy, a neutral (or choppy) to bearish outlook can make the Bear Call Spread a great strategy to use.


Definition

A Bear Call Spread is when you sell a closer-to-the-money strike (usually an at-the-money strike) and buy a further out-of-the-money strike.

This strategy is put on as a credit, which is why it's often referred to as a Credit Spread.

The reason it's called a Credit Spread is because if you write a nearby strike and buy a further out strike, you'd collect more on the nearby option you wrote and spend less on the call that you bought, thus resulting in a credit to your account.

This can also be done with puts as well. But today we'll focus on the calls.

Example

Let's say stock XYZ was trading at $50:

  • You write the November $50 Call for 5.00 and collect $500.
  • You also buy the November $55 Call for 3.00 meaning you spend $300.
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  • Net 'cost' (credit) = $200
    (i.e., collect $500 for the short $50 call, less the $300 spent for the long $55 call and that equals a credit of $200)


How Do I Win and How Do I Lose?

Your maximum potential profit will be the credit you collected when you put this trade on. And your maximum profit potential will come if the stock closes below the lowest strike price at expiration - in this case the $50 call.

Why?

Let's look at each component of the spread individually.

  • If the price of the stock stays at $50 or lower at expiration, the $50 call option you wrote for $500 will expire worthless, meaning you'd keep the entire $500 premium you collected.
  • The $55 call you purchased for $300 will also expire worthless, meaning you'd lose the entire $300 you paid.
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  • But remember, you collected $500 and lost -$300, meaning you ended up keeping the entire credit of $200 -- which is your profit.

Your maximum loss would be the difference between the two strike prices less your credit.

Why?

  • If the stock closes at the highest strike price ($55) at expiration, the $50 call that you wrote for $500 (collected) would now present a loss in premium to you of -$500, thus giving you a scratch ($0) on this side of the trade.
  • The $55 call that you bought for $300 would expire worthless, meaning you lost the entire premium paid, i.e., -$300.
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  • If you scratched on one side ($0) and lost -$300 on the other, your total loss was -$300.

If the stock went even higher, your loss would still be limited to -$300.

Why?

Because for every extra $1 you'd lose on the short call, you would make an extra $1 on the long call, thus never widening the loss.

But again, the maximum loss (albeit still limited) would come only if you are absolutely dead wrong on your neutral to bearish assumptions on the stock.

If the stock expires somewhere in between your strike prices of the short $50 call and the long $55 call, your trade would either gain a small profit or take a small loss.

Your breakeven point would be at $52.

Why?

  • Because at $52, you'd retain only $300 of the $500 premium you originally collected on the short call.
  • And you'd lose the full $300 you paid for the long call.
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  • $300 gain less -$300 loss = $0 or breakeven

  • At $53, you'd lose -$100
  • At $54, you'd lose -$200
  • And as illustrated above; at $55 and higher you'd lose -$300 (but never ever any more than that).

The profit potential is limited, but you have more ways to profit than a straight call or put can provide.

The trick is to put on a credit spread at the maximum credit you can because your maximum loss will always be the difference between the two strikes less the credit you collected. And the larger the credit, the lower your maximum loss could be and the larger your potential profit zone can be.

If you're looking for a neutral to bearish option strategy to put on with limited risk but more ways to profit than lose, consider the Bear Call Credit Spread.

You can learn more about different types of option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader service, which was up 42.8% last year and is up 30.74% so far this year.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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