Bear Call Spread – Meaning, Example and Breakeven

Bear Call Spread Meaning

Bear call spread is the term used in the context of options trading. In case of stock markets, the word bear implies a decline in price and as the name suggests bear call spread is used when one is expecting a decline in the price of the underlying asset. In bear, call spread an individual sells call options at the specific strike price and at the same time he or she buys the same number of calls at the higher strike price of the same expiry period. Under this strategy, maximum profit is limited up to the difference between the amount received from selling the call options and the amount paid for buying call option of the higher strike price.

Bear Call Spread Example

It can be better understood with the help of an example suppose an individual is bearish on Microsoft stock and he or she decides to use bear call spread. Now suppose Microsoft is trading at $300 and call option of $300 strike price is $10 and $310 strike price is $4 than an individual will sell $300 call option and receive $10 and at the same time he or she will buy $310 call option at $4. Hence the net receivable amount is $6 per lot. Now if Microsoft stock expires below $300 than an individual profit is $6 no matter how much it falls.

However if Microsoft stock rises above $310 than an individual loss will be limited to $4 per lot as loss from writing $300 call will be offset by a long position in $310 call. In simple words, the individual loss will be limited to $4 no matter what the price of Microsoft stock is at expiry.

Bear Call Spread Breakeven

The breakeven for bear call spread can be calculated as lower strike price of the option plus net premium received so in above case breakeven point for Microsoft stock will be $306. Hence if the Microsoft stock trades at $306 on expiry than a trader will make neither profit nor loss. Hence in the above strategy of Microsoft stock, the maximum profit is $6 and the maximum loss is $4.

As one can see from the above that bear call spread strategy has limited risk but at the same time, limited reward and trader using this strategy expects the underlying stock or index to be moderately bearish.

0 comments… add one

Leave a Comment