A bear call spread is an option strategy that involves the sale of a call option , and the simultaneous purchase of a different call option on the same underlying asset with the same expiration date but a higher strike price. A bear call spread is one of the four basic types of vertical spreads. As the strike price of the call sold is lower than the strike price of the call purchased in a bear call spread, the option premium received for the call sold i.
Since initiation of a bear call spread results in receipt of an upfront premium, it is also known as a credit call spread, or alternately, as a short call spread. For comparison, see also " What is a Bear Put Spread? A bear call spread is somewhat similar to the risk-mitigation strategy of buying call options to protect a short position in a stock or index. However, since the instrument 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, while in a short sale, the maximum profit is the difference between the price at which the short-sale was effected and zero the theoretical low to which a stock can decline.
Consider hypothetical stock Skyhigh Inc. He therefore initiates a bear call spread on Skyhigh as follows:. Consider the possible scenarios a month from now, in the final minutes of trading on the option expiration date:. A scenario where the stock trades below the strike price of the short call leg is the best possible one for a bear call spread.
Bob therefore has two choices: The former course of action is preferable, since the latter course of action would incur additional commissions to buy and deliver the stock. Bob therefore breaks-even on the trade but is out of pocket to the extent of the commissions paid. The maximum loss occurs when the stock trades at or above the strike price of the long call. Conversely, the maximum gain occurs when the stock trades at or below the strike price of the short call.
The bear call spread is a suitable option strategy for generating premium income during volatile times. Dictionary Term Of The Day. Broker Reviews Find the best broker for your trading or investing needs See Reviews.
Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. What is a Bear Call Spread? A bear call spread should therefore be considered in the following trading situations: Modest downside is expected: This strategy is ideal when the trader or investor expects modest downside in a stock or index, rather than a big plunge.
Because if the expectation is for a huge decline, the trader would be better off implementing a strategy such as a short sale , buying puts or initiating a bear put spread, where the potential gains are large and not restricted just to the premium received.
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 that is possible with the naked i.
Remember that selling a call imposes an obligation on the option seller to deliver the underlying security at the strike price; think of the potential loss if the underlying security soars by two or three or ten times before the call expires. Example Consider hypothetical stock Skyhigh Inc. He therefore initiates a bear call spread on Skyhigh as follows: Consider the possible scenarios a month from now, in the final minutes of trading on the option expiration date: Calculations To recap, these are the key calculations associated with a bear call spread: The bear call spread takes advantage of time decay , which is a very potent factor in option strategy.
Since most options either expire or go unexercised, the odds are on the side of the bear call spread originator. A relatively conservative trader may opt for a narrow spread where the call strike prices are not very far apart, as this will reduce the maximum risk as well as the maximum potential gain of the position. An aggressive trader may prefer a wider spread to maximize gains even if it means a bigger loss should the stock surge. Since it is a spread strategy, a bear call spread will have lower margin requirements as compared to selling naked calls.
Risks Gains are quite limited in this option strategy, and may not be enough to justify the risk of loss if the strategy does not work out. There is a significant risk of assignment on the short call leg before expiration, especially if the stock rises rapidly. This may result in the trader being forced to buy the stock in the market at a price well above the strike price of the short call, resulting in a sizeable loss instantly. This risk is much greater if the difference between the strike prices of the short call and long call is substantial.
A bear call spread works best for stocks or indexes that have elevated volatility and may trade modestly lower, which means that the range of optimal conditions for this strategy is limited. The Bottom Line The bear call spread is a suitable option strategy for generating premium income during volatile times. How much a fixed asset is worth at the end of its lease, or at the end of its useful life.
If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded. Payout ratio is the proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage. The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as No thanks, I prefer not making money.
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