Risk vs Profit Potential of a Bear Call Spread
The bear call spread is one of the option trading strategies that we use when we expect a stock or index like the S&P 500 to remain steady or fall in price. When you set up a bear call spread you will sell a call option and collect the premium and you will buy a call at a higher strike price (cheaper). Thus, you start the trade with a credit. This credit will be your profit providing that the stock price does not go up. This strategy is one of four vertical option spreads. It is also referred to as credit spread because the setup of the trade starts with a credit.
Risk of a Bear Call Spread
If you anticipate the S&P 500 dropping in price you may set up a bear call spread. If your assessment is hugely wrong the S&P 500 will go up in price. If that happens you will not have unlimited risk because you will have sold a call at a lower price and purchased a call at a higher price. Thus, your loss will be limited to the spread between the two calls minus the premium you earned when you set up the trade. While the exact amount of your potential loss will always be known with this trade, the odds of losing money will depend on how accurately you can forecast movements of a given stock price or index price.
Why Use a Bear Call Spread Instead of Just Selling a Call?
If an option trader is absolutely certain that the market will take an index or stock price downward, they could sell a call and potentially make more money than by selling the call and also buying another, albeit cheaper, call. When we sign off of our videos, we always say to make sure that you hedge. One of the best aspects of options trading is that you can limit your risk of hedge all of your trades. The point is that no one is perfect and assuming that you are perfect when you trade options without limiting your risk can result in the loss in an afternoon of all of the profit that you achieved over years.
Profit Potential of a Bear Call Spread
As we noted, you could skip the spread and just sell a call when you think the market will go down. The problem with this approach over time is that your profits will be diluted by or erased by your potentially large losses. By hedging with a bear call spread you will limit your losses on any given trade and routinely take in profits. This can be a very predictable, money making trade. Over the long haul this predictable approach to option trading has served us well at Top Gun Options by providing routine and excellent profits and only occasional and limited losses.
Option Trading in Volatile Markets
The key to success with a Bear Call Spread or any option trading strategy is to pick the right strategy for the right market. Now is a particularly difficult time for trading and not a good time to be trading alone. Considering signing up with one of the trading squadrons at Top Gun Options where we potentially print money no matter which way the market is headed.
Originally published at https://topgunoptions.com on September 10, 2022.