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Bear Call Spread - An Option Trading Strategy

We shall study the bear call spread options strategy on this page today. A bear call credit spread has multiple legs. In this strategy, the risk is defined, and also the profit is limited. The strategy aims to profit from the price fall of the underlying asset before the contract expires.


In bear call spreads, traders sell call options and buy call options contracts at a higher price. As said, the strategy can be profitable if the underlying stock's price falls. The factors such as theta (time decay) and decline in implied volatility will help this strategy to gain profit.


Market outlook of the bear call credit spread option strategy:

When a trader believes that the stock price will close at a price below the short call option strike price on or anytime before the contract expires, it is the best time to utilize this strategy. This strategy is called credit spread in the market, as it collects the credit upon entering. Traders may earn high profits if they select a strike price closer to the stock-price of the underlying asset.


In this strategy, traders sell a short-call option and buy a long-call option at a high strike price. The credit amount received as a premium will be the maximum profit on the position. The highest risk will be the spread's width minus the premium amount gained. The large width will allow it to collect more premium.


How to enter the Bear call credit spread?

In order to enter this strategy, traders follow the order as follows - sell-to-open (STO) call option and buy-to-open (BTO) call option, this one at the higher price, and both having the same expiry date. This order will come to the credit received for the situation. The purchase of the long call option will reduce the premium but will help define the risk on the position by creating the width.


Suppose a trader believes that the stock price will fall below ₹50 at the time of expiry. He can sell the call option at ₹50 and will purchase a call option at ₹ 55. It will lead to a credit of ₹1. Now, the profit is defined by this strategy. If the stock closes at a price below ₹50 at expiry, he will earn a profit of ₹100. If the stock closes above ₹55 at expiry, this case trader will have a loss of ₹400.

  • Sell-to-open -₹50 call option contract

  • But-to-open - ₹55 call option contract

Bear Call Spread - An Option Trading Strategy

Understanding the diagram of Bear call credit spread:

You can see the risk and rewards of the spread clearly in this diagram. Traders collect the credit upon entering the strategy. This credit is the highest profit a trader can have on this strategy.


In this example, the trader has collected ₹1 as credit, and thus ₹100 will be the max profit. The break-even point of the strategy would be the strike-price of the short call plus the amount of premium received.


How to exit from a bear call spread strategy?

  • To exit from the strategy, traders can reverse the position by reversing the buy-to-close (BTC) short call option and the sell-to-close long option.

  • If the spread is bought at a lower price than it was sold, in this case, the trader will have the profit.

  • If the stock closes at a price below than the short call's option, then both the contracts will expire worthless, and the trader can keep the premium as a profit.

  • If the stock closes above the strike-price of the long call at the time of expiry, the trader will have the max loss.

Additional notes on this strategy:

  • The time decay and theta factor work in favor of the strategy.

  • This strategy makes more profit when the implied volatility decreases.

  • If the market scenario is not in your favor, you may adjust the strategy by adding a bull put credit spread.

  • To extend the duration of the strategy, traders may buy the existing strategy and sell a new spread with a new expiry date.

Conclusion:

Thus, we have seen how you can make a profit when the stock price is declining in the market. This may be the reason why options are prevalent in the market; they can help you make a profit in every type of market scenario.

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