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The purpose of this strategy is to profit if the stock declines in value. However, shorting involves significant risk, as a stock can go up indefinitely; your potential loss is technically unlimited.
If you think a stock is overpriced and might decline, the bear call spread is a strategy that can facilitate trading this expectation, while limiting the associated risk. A bear call spread involves selling a call with a strike price at or above the current market price and purchasing another call with a higher strike price.
This creates a position for which the potential loss is limited, compared with a naked short position, which has unlimited loss potential. The trade-off for limiting risk of loss is that there is a limit to your potential profits. The bear call spread is similar to the bear put spread: Both strategies anticipate a decline in the underlying stock. The obvious dissimilarity is that calls, instead of puts, are purchased and sold, but the key difference is that a bear call spread is a credit spread.
That is, you take in income at the outset of this trade. On the other hand, the bear put spread is a debit spread; you pay at the outset of the trade.
Which strategy should you implement? You may want to assess the maximum potential profit and loss of both to determine which one to use if you expect the underlying price to decline. Fortunately, both strategies allow you to identify the maximum potential profit or loss in advance. Alternatively, the bear put spread's maximum potential profit is the difference in the strike prices less the net cost of the trade, while the maximum risk is the initial cost of the spread. You can consider the implied volatility of the options, relative to their historic volatility, to help you make a determination as to which strategy to use:.
Normally, you will use the bear call spread if you are neutral or moderately bearish on a stock. Your goal is for the underlying stock to remain below the strike price of the sold call. This spread effectively allows you to potentially profit if the stock declines in value by keeping the income from the sold call, less the cost of the purchased call , while limiting your potential loss in the event that the stock rises in value.
If the stock does rise, the potential loss could be partially offset by the credit taken in at the outset of the trade.
Also, if the stock rises above the strike price of the purchased call, losses on the sold call will be offset by gains on the purchased call, assuming the stock price rises significantly. Preparation is very important when trading options. Here are some general guidelines that you may want to follow before entering into a bear call spread:. One way this can be accomplished is by analyzing options greeks —particularly the delta of the sold call.
The delta provides an approximate probability of the contracts expiring worthless and, thus, the likelihood you will be able to keep the credit.
An example of using greeks would be a short call that has a delta of Now that you have a basic idea of how this strategy works, let's look at a hypothetical example to get a better sense of it. You decide to initiate a bear call spread. However, if the stock price rises, your position is subject to potential losses. Now, let's assume the price moves in several directions.
Given that the underlying stock price can move in either direction during the life of the contract, it is possible to actively manage your trade to lock in profits or prevent further losses. One way this can be done is by repurchasing the sold option in the open market to effectively lock in the position. To cap your losses on the position, you could buy to close the XYZ August 30 call, which would offset the call you sold at the outset of the trade.
With some experience, you may be able to more effectively manage this trade. So, if you are neutral or moderately bearish on a stock and would like to limit your risk exposure, consider the bear call spread. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options.
Supporting documentation for any claims, if applicable, will be furnished upon request. Dow days of summer. View all Technical Analysis articles. Skip to Main Content. Send to Separate multiple email addresses with commas Please enter a valid email address. Your email address Please enter a valid email address. Read relevant legal disclosures.
Before placing a spread with Fidelity, you must fill out an options agreement and be approved for Level 3 options trading. Contact your Fidelity representative if you have questions. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared to a single option trade. Views and opinions expressed may not reflect those of Fidelity Investments.
These comments should not be viewed as a recommendation for or against any particular security or trading strategy. Views and opinions are subject to change at any time based on market and other conditions. Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.
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