Bear Call Spreads

Bear Call Option Spreads Explained

Bear call spreads are also known as call credit spreads. They are a bearish selling options trading strategy involving selling and buying another call with the same expiration date. This combination process enables the options seller to receive a net premium, and the seller gets to keep this premium if the price expires away from the short strike by expiration.

We’ll refer to all three names for this strategy in this article. This is so you’re made aware they’re all the same thing! That said, traders associate “bear” with falling stock prices. The term “short” or “short in the market” is a trading strategy in which you profit from falling prices in securities.

So, you aim to make money from neutral or bearish price action in the underlying stock and put time on your side.

With this in mind, credit refers to the fact that this options strategy puts a net credit in your account.

  1. Bear call spreads are short or bear call credit spreads. Options traders use this strategy when they feel the underlying security price will decrease.
  2. Sell a call, strike price A (short call)
  3. Buy a call, strike price B (long call)
  4. Receive net credit in your account
  5. You profit if the price falls, time decays, or a combo of both

Bear Call Spread Example

  1. To use this strategy, you have two steps to follow. First, you purchase a call option (or more than one) at a certain strike price (B).
  2. Second, you sell the same number of call options with the identical expiration date. However, the call option you’re selling must be at a lower strike price (A) than the one you’re buying (B) for this strategy to be properly implemented.
  3. Typically, the stock price will be below strike A. Let’s get to the good part now. The bear call spread is now in the books as an open trade. Congratulations!
  4. You took in a net credit in the form of money. As a result, you COULD keep the profits thanks to either a declining stock price, time erosion, or a combination of the two.
  5. Your loss is limited because you are treading a spread, which fixes your max loss and gain. It also gives you a higher chance of success (probability). You can close your trade anywhere, whether a small profit or loss. You don’t have to keep your trade open till your expiration date.
Bear Call Spreads

Let’s explain this simply here with the diagram above:

  • Sell a call, strike price A (short call) – let’s say the strike is \$50.
  • Buy a call, strike price B (long call) – let’s say the strike price is $55.
  • Don’t forget to pick the SAME EXPIRATION DATE!

Bear Call Spread Advantages

One thing to pat yourself on the back for is limiting your risk. Your bear call spread reduces your risk of losing money and fixes it to a set amount.

We at the Bullish Bears can’t emphasize the importance of risk management. By buying a call option with a higher strike price (B), you offset the risk of selling the call option with a lower strike price (A).

Moreover, a bear call spread is much less risky than shorting a stock. Theoretically, when shorting a stock, you have unlimited risk if the stock price moves higher. However, with a short call spread, your maximum loss is only the difference between the two strike prices.

On the negative side, if the price falls further than strike price A, you miss out on any additional payoffs. In essence, that’s your trade-off between risk and reward. However, I believe the limited risk is appealing to so many traders.

Maximum Profit

A bear call spread makes the maximum profit when the stock price is at or below the strike price of the short call (A) at expiration. For this reason, you want the stock price to be at or below strike A at expiration, so both options expire worthlessly.

Profits from bear call spreads are capped to the net premium received minus your commission fees when the trade is placed. Check out our trading service to learn more about options trading.

Maximum Loss

Now, let’s talk about what you could lose in the trade. Luckily, you’re trading a spread, so it’s capped. Therefore, your maximum loss is the difference between the two strike prices minus the net credit received, including commissions paid. Let’s break this down from the example above:

Difference between strike prices = 5 (105.00 – 100 = 5)

Net Credit = 1.80 (3.30 – 1.50 = 1.80)

Maximum Risk = 3.20 (5.00 – 1.80 – 3.20) per share less commissions

Your maximum loss happens if the stock price exceeds the strike price of the long call option at expiration. In our example, the long call option is strike price B.

Break-even Stock Price At Expiration = Strike price of short call (100.00) + net premium received (1.80) = 101.80

Trading a Bear Call Spread Strategy

  • Bear call credit spreads or short call spreads look to limit risk while collecting option premiums simultaneously. Put another way, they profit from falling stock prices and time decay.
  • For this strategy, the net effect of time decay is somewhat positive. It will erode the value of the option you sold (good) but also the value of the option you bought (bad). Further to this, you want both options to expire worthless. If that happens, you won’t have to pay commissions to get out of your position.
Bear Call Example

Sell 1 ABC 100 call at 3.30

Buy 1 ABC 105 call at (150)

Net Credit = 1.80

When Should You Trade Them?

A bear call spread is your ideal play when you think the price of a stock will fall between the trade and expiration date.

Put simply, you’ll benefit from using a bear call spread when the underlying price falls. In contrast, you’ll lose as the price rises – no real surprise here.

In the options arena, your position has a “net negative delta.” We use Delta to estimate how much the option will change in price when the stock changes. An important point to remember is even though the stock might move up/down a dollar, the option value does not mirror that move.

Moreover, since this setup includes one long and one short call, the net delta doesn’t change much as the stock price changes, and the time to expiration is unchanged.

In other words, this is a “near-zero gamma.” Gamma estimates how much the delta will change as the stock price changes.

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Risk of Early Assignment

Unfortunately, with bear call spreads, an early assignment is possible. Typically, short calls get assigned if the stock price exceeds the strike price at expiration, which makes sense.

If you didn’t know, stock options in the US can be exercised on any business day. This means if you’re a holder of a short stock option position, you have zero, yes, I said zero, control over when you might have to fulfill the obligation.

The risk is real and must be considered before entering into short-option positions. You don’t need to worry about the early assignment with the long call (higher strike price, B). Well, because you own the option to buy, that’s what a call is.

On the other hand, your exposure to risk (potential loss of capital) is with the option contract you sold. Someone bought it with the expectation that they would get 100 shares if desired.

In most cases, the early assignment of stock options is tied to dividends, and you’ll see the assignment on the day before the dividend date. So pay attention to ex-dividend dates and avoid trading near them if this concerns you.

If you find yourself in this situation, you need to deliver the shares by either buying the stock outright from the market or exercising your long call option, simple as that.

The downside here is the fees – interest, commissions, and the potential for the dreaded margin call if you don’t have enough equity in your account to support your position.

Possibilities at Expiration

  1. The stock price is at or below the lower strike priceBoth the calls in the spread expire worthless. As a result, your account has no stock position created. This is the best-case scenario because you can keep the credit (the premium you took).
  2. The stock price is above the lower strike price but not the higher one. Here, the short call has been assigned to you. You know, hold 100 shares short of stock in your account. Don’t worry; you can immediately cover the short position by buying shares if you need to.
  3. The stock price is above the higher strike price. The short call is assigned, and the long call is exercised. The broker you use is familiar with executing these orders—result: no stock position. But you did lose on the trade.

Key Takeaways

  • Build them by purchasing two call options, one long and one short, with different strike prices but the same expiration date.
  • Limited risk and limited reward because traders can control their losses, limiting their rewards.
  • The strike prices determine the profits and losses
  • Run it if you feel the stock price will decline
  • Time decay is your friend
  • There’s a risk of early assignment on the call option you sold

Final Thoughts: Bear Call Spreads

The main advantage of bear call spreads is risk reduction because you don’t own the underlying security. Your loss is capped. Therefore, you don’t have to worry about losing your shirt if the stock price goes wrong.  It’s a win-win all around.

So, I encourage you to learn how to run option spreads. Many trade them for a living. They’re a great way to minimize risk and live to trade another day, and we’ll show you how!

If you need more help, take our options trading course.

Frequently Asked Questions

Bear call spreads are profitable if the stock price holds steady or declines. It has limited risk and limited reward.

A bear call spread is a trading strategy that collects an option premium and also limits risk. Traders profit from both time decay and declining stock prices. 

A bear put spread works best when the underlying stock's price falls below the short put's strike before the expiration date. 

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