Bear Call Spread Option Trading Strategy Explained

Published on Wednesday, April 18, 2018 | Modified on Wednesday, June 5, 2019

Bear Call Spread Options Strategy

Strategy Level	Beginners
Instruments Traded	Call
Number of Positions	2
Market View	Bearish
Risk Profile	Limited
Reward Profile	Limited
Breakeven Point	Strike Price of Short Call + Net Premium Received

A Bear Call Spread strategy involves buying a Call Option while simultaneously selling a Call Option of lower strike price on same underlying asset and expiry date. You receive a premium for selling a Call Option and pay a premium for buying a Call Option. So your cost of investment is much lower. The strategy is less risky with the reward limited to the difference in premium received and paid.

This strategy is used when the trader believes that the price of underlying asset will go down moderately. This strategy is also known as the bear call credit spread as a net credit is received upon entering the trade.

The risk and reward both are limited in the strategy.

How to use the bear call spread options strategy?

The bear call spread strategy looks like as below for NIFTY which is currently traded at Rs 10400 (NIFTY Spot Price):

Suppose NIFTY shares are trading at 10400. If we are expecting the price of NIFTY to go down in near future, we sell 1 ITM NIFTY Call and buy 1 OTM NIFTY Call.

The trader receives a higher premium for selling a Call while paying the lower premium for buying a Call. If the NIFTY goes down, trader keeps the net premium received which is also the maximum profit.

If the price of Nifty rises, your loss will be limited to the difference between two strike prices minus the net premium received at the time of entering into the strategy.

When to use Bear Call Spread strategy?

The bear call spread options strategy is used when you are bearish in market view. The strategy minimizes your risk in the event of prime movements going against your expectations.

Example

Example 1 - Stock Options:

Let's take a simple example of a stock trading at Rs 37 (spot price) in June. The option contracts for this stock are available at the premium of:

• July 40 Call - Rs 1
• July 35 Call - Rs 3

Lot size: 100 shares in 1 lot

1. Buy July 40 Call: 100*1 = Rs 100 Paid
2. Sell July 35 Call: 100*2 = Rs 300 Received

Net Credit: Rs 100 + Rs 300 = Rs 200

Now let's discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at Rs 37

• July 40 Call - Expires worthless
• July 35 Call - Expires worthless
• Net credit was Rs 200 which was received as net premium for Call position.
• Total proft = Rs 200

The total profit of Rs 200 is also the maximum profit in this strategy. This is the amount you paid as premium at the time you enter in the trade.

Scenario 2: Stock price goes up to Rs 42

• Buy July 40 Call Expires in-the-money with an intrinsic value of (42-40)*100 = Rs 200
• Sell July 35 Call Expires in-the-money with an intrinsic value of (35-42)*100 = -Rs 700
• Net credit was Rs 200 which was received as net premium.
• Total Loss = -700 + 200 + 200 (Premium Received) = -Rs 300

In this scenario, we lost total Rs 300 which is also the maximum loss in this strategy.

Scenario 3: Stock price goes down to Rs 30

Same as scenario 1:

• July 40 Call - Expires worthless
• July 35 Call - Expires worthless
• Net credit was Rs 200 which was received as net premium for Call position.
• Total proft = Rs 200

Example 2 - Bank Nifty

Market View - Bearish

When you are expecting the price of the underlying to moderately go down.

Actions

• Buy OTM Call Option
• Sell ITM Call Option

Let's assume you're Bearish on Nifty and are expecting mild drop in the price. You can deploy Bear Call strategy by selling a Call Option with lower strike and buying a Call Option with higher strike. You will receive a higher premium for selling a Call while pay lower premium for buying a Call. The net premium will be your profit. If the price of Nifty rises, your loss will be limited to difference between two strike prices minus net premium.

Breakeven Point

Strike Price of Short Call + Net Premium Received

The break even point is achieved when the price of the underlying is equal to strike price of the short Call plus net premium received.

How to exit?

• Wait for Options to expire and retain premium.
• Reverse you position by buying back the sold Call and selling the bought Call.

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