How Do I Make Money In A Bear Call Spread?

A bear call spread is a limited-gamble, express-reward strategy, consisting of one brusk call option and one long phone call pick.

Clarification

A behave call spread is a type of vertical spread. Information technology contains two calls with the same expiration merely different strikes. The strike price of the short call is below the strike of the long call, which means this strategy will e'er generate a net cash inflow (cyberspace credit) at the outset.

The brusque phone call's chief purpose is to generate income, whereas the long call just helps limit the upside risk.

The profitability of the strategy depends on how much of the initial premium revenue is retained before the strategy is closed out or expires. As the strategy's name suggests, it does all-time if the stock stays below the lower strike price for the duration of the options.

All the same, an unexpected rally should not provoke a crisis: though the maximum proceeds of this strategy is very limited, so are potential losses.

It is interesting to compare this strategy to the bear put spread. The profit/loss payoff profiles are exactly the same, once adjusted for the net price to comport.

Bear Call Spread Diagram — Net Position (at expiration)

Case

Short 1 XYZ lx phone call
Long 1 XYZ 65 telephone call

MAXIMUM Gain

Cyberspace premium received

MAXIMUM LOSS

High strike - low strike - net premium received

The primary difference is the timing of the greenbacks flows. The bear put spread requires a known initial outlay for an unknown eventual return; the deport call spread produces a known initial cash inflow in commutation for a possible outlay afterward on.

Outlook

Looking for a refuse in the underlying stock'due south price during the life of the options. As with any limited-time strategy, the investor'southward long-term forecast for the underlying stock isn't as important, simply this is probably non a suitable choice for those who take a bearish outlook by the immediate future. It would take an accurately timed forecast to pinpoint the turning point where a coming curt-term rally would turn into a bearish long term.

Summary

A deport call spread is a limited-risk, limited-reward strategy, consisting of one brusque call option and ane long phone call option. This strategy generally profits if the stock price holds steady or declines.

The nearly it can generate is the net premium received at the first. If the forecast is incorrect and the stock rallies instead, the losses grow only until the long phone call caps the amount.

Motivation

The chance to earn income with limited adventure, and/or profit from a refuse in the underlying stock's price.

Variations

A vertical call spread can be a bullish or surly strategy, depending on how the strike prices are selected for the long and brusque positions. See bull phone call spread for the bullish counterpart.

Max Loss

The maximum loss is limited. The worst that tin can happen at expiration is for the stock toll to be above the higher strike. In that case, the investor will exist assigned on the short call, now deep-in-the-money, and will practise the long call. The simultaneous do and assignment will hateful selling the stock at the lower strike and buying the stock at the higher strike. The maximum loss is the difference between the two strikes, but it is reduced by the net credit received at the offset.

Max Gain

The maximum proceeds is express. The all-time that can happen at expiration is for the stock to be below both strike prices. In that case, both the short and long call options expire worthless, and the investor pockets the credit received when putting on the position.

Profit/Loss

Both the potential profit and loss for this strategy are very limited and very well-defined. The initial net credit is the well-nigh the investor can promise to make with the strategy. Profits at expiration offset to erode if the stock is above the lower strike price, and losses reach their maximum if the stock hits the college strike price. Above the higher strike cost, profits from exercising the long phone call completely start further losses on the brusque call.

The way in which the investor selects the 2 strike prices determines the maximum income potential and maximum adventure. Past selecting a lower short call strike and/or a college long phone call strike, the investor tin increase the initial net premium income.

Breakeven

This strategy breaks even at expiration if the stock price is above the lower strike by the amount of the initial credit received. In that instance the long call would expire worthless, and the short telephone call'due south intrinsic value would equal the net credit.

Breakeven = short phone call strike + cyberspace credit received

Volatility

Slight, all other things being equal. Since the strategy involves being brusque one phone call and long another with the same expiration, the effects of volatility shifts on the two contracts may first each other to a large degree.

Note, however, that the stock price can motility in such a style that a volatility change would touch on one price more than the other.

Time Decay

The passage of time helps the position, though not quite as much as it does a plain brusque phone call position. Since the strategy involves being short one call and long another with the same expiration, the furnishings of time decay on the two contracts may kickoff each other to a big degree.

Regardless of the theoretical impact of time erosion on the ii contracts, it makes sense to call up the passage of time would be a positive. This strategy generates internet upwardly-forepart premium income, which represents the most the investor can brand on the strategy. If there are to be any claims against it, they must be occur by expiration. As expiration nears, and then does the engagement subsequently which the investor is gratuitous of those obligations.

Assignment Risk

Yes. Early assignment, while possible at whatever time, generally occurs when the stock goes ex-dividend. Be warned, however, that using the long call to cover the short phone call assignment volition require establishing a short stock position for one business day, due to the delay in receiving assignment notification.

And exist aware, a situation where a stock is involved in a restructuring or capitalization event, such equally for case a merger, takeover, spin-off or special dividend, could completely upset typical expectations regarding early do of options on the stock.

Expiration Take chances

Yep. The investor cannot know for sure whether or not they were assigned on the short call until the Mon later expiration. That creates risk. The trouble is most acute if the stock is trading only below, at or just higher up the brusk call strike.

Say the short telephone call ends upward slightly in-the-money, and the investor buys the stock in the market in anticipation of being assigned. If consignment fails to occur, the investor won't observe the unintended internet long stock position until the post-obit Monday and is subject to an adverse move in the stock over the weekend.

At that place is risk in guessing wrong in the other management, as well. This time, assume the investor bets against being assigned. Come Monday, if assignment occurred subsequently all, the investor is unexpectedly short the stock, and its value may accept risen over the weekend.

2 means to prepare: close the spread out early, or exist prepared for either outcome on Monday. Either way, it'southward important to monitor the stock, especially over the last twenty-four hours of trading.

Comments

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Related Position

Comparable Position: Bear Put Spread

Opposite Position: Bull Call Spread

Source: https://www.optionseducation.org/strategies/all-strategies/bear-call-spread-credit-call-spread

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