The bear call spread and the bear put spread are option strategies used when an investor expects the price of the underlying security to fall.
These strategies can be advantageous for investors when trying to profit off of the decline in the underlying security’s price. This article will explain the basics of the bear call spread and the bear put spread.
If you are unsure of what call and put options are, then click on this article.
A bear call spread is achieved by purchasing a call option at a certain strike price while selling a call option with the same expiration date, but a lower strike price. The potential profit gained from this strategy is the premium received when selling the option minus the cost of buying of the other option.
Let’s look an example.
Assume a stock is trading at $20. An investor uses a bear call spread by buying one call option with a strike price of $25 for a premium of $0.50 per share. Simultaneously, he sells one call option with a strike price of $20 for a premium of $2.50 per share. If the stock price falls below $20, then both options will expire worthless. The investor will profit $2.00 per share because of the premiums (2.50 – .50 = 2).
Similarly, a bear put spread is achieved by purchasing a put option at a certain strike price while selling a put option with the same expiration date, but a lower strike price. The potential profit gained from this strategy is the difference between the two strike prices, minus the total cost of the option.
Let’s look at an example of this strategy.
Assume a stock is trading at $20. An investor uses a bear put spread by buying one put option contract with a strike price of $25 for a premium of $5 per share. At the same time, he sells one put option with a strike price of $20 for a premium of $2. At this point the investor is at a loss of $3 per share. However, assume the stock closes below $20 at expiration. The investor will profit from the difference in strike prices, minus the total cost of the options. In this case, the investor will profit $2 per share ((25 – 20) – (5 – 2) = 2).
Both of these strategies are advantageous because they reduce the total risk of the trade. They each offer the opportunity to profit if the underlying security’s price goes down.
These are good strategies to keep in mind when trading options.
