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Financial Literacy

What is a Bear Call Spread?

Experienced options traders know that there are more ways to profit from options than just purchasing them and hoping they land in the money. There are ways to mitigate risk and maximize the potential for ROI, but it often involves leveraging multiple options. Vertical spreads are a great example, and few strategies are as foolproof as a bear call spread

Bear call spreads allow speculative traders to bet on the poor performance of a stock, without the inherent risk that comes from outright shorting it. Stacking call options makes it possible to hedge risk, without giving up too much in potential returns. It’s a way to speculate about poor price performance without actually exposing yourself to it. 

Here’s a look at bear call spreads: how they work, their benefits and successful strategies for deploying them. 

Can you make a bear call spread

An Introduction to Vertical Spreads

Before we can talk about bear call spreads, it’s important to have a fundamental understanding of vertical option spreads. The concept of a vertical spread is simple, and involves two options. Here’s how one works.

A trader buys an option for ABC Company at $X, while at the same time selling an option for the same company at a different strike price, $Y. This strategy hedges against losses by limiting the amount of risk the trader exposes themselves to. Buying an option creates the potential for return; writing an option protects against loss. 

Vertical spreads can be bullish or bearish, depending on the scattering of puts and calls. Bull vertical spreads profit when the price of the underlying security rises; bear vertical spreads profit when the security’s price falls. 

How a Bear Call Spread Works

A bear call spread is simply a vertical call spread that bets on poor price performance. It’s sometimes called a credit spread, because the trader receives a net credit when setting up the strategy. To facilitate it, the trader sells a call option, while simultaneously purchasing another one for the same security at a higher strike price. Both options have the same expiration date. 

In this strategy, the trader profits on the “short” call strike price and limits their losses on the “long” call strike price. Best case scenario? They reap the full ROI of the sold call while the purchased call expires out of the money. Worst case scenario? They lose on the sold call but limit their losses thanks to the purchased call. Here’s an example:

ABC Company currently trades for $55. Harold buys a call option with a strike price of $50 at a premium of $0.25 ($25). Then, he writes a call option with a strike price of $40 for $1.50 ($150). If ABC Company closes lower than $40, Harold will realize a maximum profit of $125—the difference of the two contracts. If it closes between $40 and $50, profit will reduce the closer it gets to $40. If it closes above $50, Harold will lose the difference between the two strike prices ($1000), less the sum of the contracts ($175): $825. 

As you can see, a bear call spread still embodies plenty of risk—any short position is inherently risky. The purpose of the bear call spread is to reduce the total amount of risk and potential loss associated with speculating on bearish outcomes. 

Bear Call Spreads vs. Bear Put Spreads

Another bearish vertical spread is the bear put spread. This strategy works similar to a bear call spread, only with put options. To execute one, an investor would purchase a put option, while writing another put option with a lower strike price on the same stock, with the same expiration date. The process simply reverses the strikes that a bearish investor buys and sells their options at. This strategy is also known as a debit spread because it results in a net outflow of money to set it up. 

When to Use a Bear Call Spread

A bear put spread is generally recognized as a “modestly bearish” options trading strategy. That means it’s best deployed when there’s market volatility that’s generally trending down. Downtrend over several trading periods and forward-looking negative sentiments open the door for bearish vertical options. 

Many traders will also use bear call spreads at the behest of technical trading patterns. Descending triangles, bearish flags, bearish pennants and other down-trending chart patterns are prime indicators that bearish sentiment will continue. Two black gapping, three black crows and other bearish candlestick patterns can also signal an opportunity to deploy a bear call spread. Traders can use technical analysis to set price targets, as well as entry and exit points in the future. This paves the way for choosing call options that fit within the parameters of the pattern. 

As a hedging tool, many traders also use bear call spreads to safeguard against volatility when buying or selling the underlying security. Bearish call spreads can help protect against price depreciation. If you own the security and the stock price falls, you hedge and profit from a well-timed bear call spread. 

Be Careful with Bearish Options

While not as risky as shorting stocks outright, bearish options are nevertheless risky. Vertical options stacking like a bear call spread can mitigate some of that risk, but you’re still betting on poor performance. The market can swiftly punish those who don’t safeguard themselves. Use bear call spreads in conjunction with smart trading practices and sound technical analysis to minimize losses and maximize profitability when buying and writing call options.


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