What Is a Bear Call Spread?

With a bear call spread, traders sell a call at a higher strike price and buy one at a lower price to earn a net premium while betting on a price decline or stability in an underlying security with limited risk.

Oct 17, 2024 at 05:48 pm

1. Understanding Bear Call Spreads

Definition:

A bear call spread is an options trading strategy that involves selling a higher-strike call option and buying a lower-strike call option on the same underlying security, both with the same expiration date.

2. Structure of a Bear Call Spread:

• Leg 1: Sell a call option with a higher strike price (OTM or slightly ITM).
• Leg 2: Buy a call option with a lower strike price (usually OTM or deeply ITM).
• Net Premium: The net premium received from selling the higher-strike call is greater than the premium paid for buying the lower-strike call.

3. Profit and Loss Profile:

• Profit: Bear call spreads profit when the underlying security price falls or remains below the strike price of the sold call.
• Loss: Bear call spreads incur a loss when the underlying security price rises above the strike price of the sold call.

4. Breakeven Point:

The breakeven point for a bear call spread is the underlying security price at which the profit and loss break even. It is calculated as follows:

Breakeven Point = (Strike Price of Sold Call - Strike Price of Bought Call) + (Net Premium Received)

5. Strategy Analysis:

• Bullish Outlook: Bear call spreads are suitable when the trader has a bearish outlook on the underlying security and expects its price to fall or remain below the strike price of the sold call.
• Limited Risk: The maximum loss is limited to the net premium received.
• Neutral Theta: Bear call spreads have neutral theta to options, meaning they do not gain or lose value over time due to the passage of time.
• Income Generation: Bear call spreads can generate income if the underlying security price remains below the breakeven point.