Options Trading 101: The Bear Call Spread

The bear call spread is used to profit from an expected drop in the price of the market. The strategy writes call options as opposed to buying call options for the bull call spread. When writing options, remember there is an advantage to the passage of time. There is a time value to options that goes above and beyond the true option value considered at time of expiration. If this time value is great, then some or all of it can essentially be reaped when writing options, especially in a spread where the risk is determined at time of purchase.

The bear call spread is different from bear put spreads. Where the bear put spread is advantageous to a delayed decline in price the bear call spread can be more advantageous to an imminent decline.

Take for example the S&P 500, let's say it is trading near 1200 and the strike prices for the bear call spread are 1100 and 1200. Which of these will be bought and which one will be written ? The 1100 call will be written and the 1200 call will be bought. That means the profit zone is anywhere between 1100 and 1200, with a maximum profit if the S&P 500 reaches 1100 or lower.

Keep in mind, that in terms of the brokerage account this is considered a credit spread. In other words, another title for the bear call spread is a credit call spread. The example above was essentially an at the money credit call spread. This will receive a net credit which is greater than an above the money spread and is less than a below the money spread.

A net credit is premium which is collected into the account which is marginable. So if the net credit premium for the at the money example is $1,000 once the market stays the same level, goes lower, anything but increase in value the erosion of the premium will turn profit for the account. Let's say with a month left until expiration the net credit is now $500. This means that a new trader who wishes to perform the same credit call spread will be collecting only $500, and if you wish to close the trade your profit will be the $500, essentially the collection of the premium that had eroded.

Now if the credit call spread is done above the money, essentially in this instance above 1200, the amount of premium collected will be less yet there will be a higher probability that the strategy will be profitable. The opposite is true for a below the money spread, which would be below 1200. The amount of premium collected will be greater yet there is a lower probability that the strategy will be successful.

All in all, the best way to use this strategy is to trade an at the money strike price on the write side and leave the trade to expire no more than 6 months.

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