Tuesday, December 18, 2018
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Bear Spread (call & put)

bear spread (call & put)

bear spreads

a bear spread is an option spread strategy used by the option trader who is expecting the price of the underlying security to fall.

vertical bear spreads

the vertical bear spread is a vertical spread in which options with a lower striking price are sold and options with a higher striking price are purchased. depending on whether calls or puts are used, the vertical bear spread can be entered with a net credit or a net debit.

vertical bear credit spread

a vertical bear spread can be established for a net credit if call options are used. the strategy is also known as the bear call spread.

vertical bear debit spread

a vertical bear spread can be established for a net debit if put options are used. the strategy is also known as the bear put spread.

 

horizontal & diagonal bear spreads

the bear calendar spread and the diagonal bear spread are both time spread strategies used by option traders who believe that the price of the underlying security will remain stable in the near term but will eventually fall in the long term.

bear call spread

the bear call spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will go down moderately in the near term.

the bear call spread option strategy is also known as the bear call credit spread as a credit is received upon entering the trade.

bear call spread construction
buy 1 out the money call
sell 1 in the money call

bear call spreads can be implemented by buying call options of a certain strike price and selling the same number of call options of lower strike price on the same underlying security expiring in the same month.

limited downside profit

the maximum gain attainable using the bear call spread options strategy is the credit received upon entering the trade. to reach the maximum profit, the stock price needs to close below the strike price of the lower striking call sold at expiration date where both options would expire worthless.

the formula for calculating maximum profit is given below:
  •  max profit = net premium received - commissions paid
  •  max profit achieved when price of underlying

limited upside risk

if the stock price rise above the strike price of the higher strike call at the expiration date, then the bear call spread strategy suffers a maximum loss equals to the difference in strike price between the two options minus the original credit taken in when entering the position.

the formula for calculating maximum loss is given below:
  •  max loss = strike price of long call - strike price of short call - net premium received + commissions paid
  •  max loss occurs when price of underlying >= strike price of long call

breakeven point(s)

the underlier price at which break-even is achieved for the bear call spread position can be calculated using the following formula.
  • breakeven point = strike price of short call + net premium received

bear-call-spread

bear call spread example

suppose xyz stock is trading at $37 in june. an options trader bearish on xyz decides to enter a bear call spread position by buying a jul 40 call for $100 and selling a jul 35 call for $300 at the same time, giving him a net $200 credit for entering this trade.

the price of xyz stock subsequently drops to $34 at expiration. as both options expire worthless, the options trader gets to keep the entire credit of $200 as profit.

if the stock had rallied to $42 instead, both calls will expire in-the-money with the jul 40 call bought having $200 in intrinsic value and the jul 35 call sold having $700 in intrinsic value. the spread would then have a net value of $500 (the difference in strike price). since the trader have to buy back the spread for $500, this means that he will have a net loss of $300 after deducting the $200 credit he earned when he put on the spread position.

note: while we have covered the use of this strategy with reference to stock options, the bear call spread is equally applicable using etf options, index options as well as options on futures.

commissions

for ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

however, for active traders, commissions can eat up a sizable portion of their profits in the long run. if you trade options actively, it is wise to look for a low commissions broker. traders who trade large number of contracts in each trade should check out optionshouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).

bear put spread

the bear put spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will go down moderately in the near term.

bear put spreads can be implemented by buying a higher striking in-the-money put option and selling a lower striking out-of-the-money put option of the same underlying security with the same expiration date.

bear put spread construction
buy 1 in the money put
sell 1 out the money put

by shorting the out-of-the-money put, the options trader reduces the cost of establishing the bearish position but forgoes the chance of making a large profit in the event that the underlying asset price plummets. the bear put spread options strategy is also know as the bear put debit spread as a debit is taken upon entering the trade.

limited downside profit

to reach maximum profit, the stock price need to close below the strike price of the out-of-the-money puts on the expiration date. both options expire in the money but the higher strike put that was purchased will have higher intrinsic value than the lower strike put that was sold. thus, maximum profit for the bear put spread option strategy is equal to the difference in strike price minus the debit taken when the position was entered.

the formula for calculating maximum profit is given below:

  • max profit = strike price of long put - strike price of short put - net premium paid - commissions paid
  • max profit achieved when price of underlying

limited upside risk

if the stock price rise above the in-the-money put option strike price at the expiration date, then the bear put spread strategy suffers a maximum loss equal to the debit taken when putting on the trade.

the formula for calculating maximum loss is given below:

  • max loss = net premium paid + commissions paid
  • max loss occurs when price of underlying >= strike price of long put

breakeven point(s)

the underlier price at which break-even is achieved for the bear put spread position can be calculated using the following formula.

  • breakeven point = strike price of long put - net premium paid

bear-put-spread

bear put spread example

suppose xyz stock is trading at $38 in june. an options trader bearish on xyz decides to enter a bear put spread position by buying a jul 40 put for $300 and sell a jul 35 put for $100 at the same time, resulting in a net debit of $200 for entering this position.

the price of xyz stock subsequently drops to $34 at expiration. both puts expire in-the-money with the jul 40 call bought having $600 in intrinsic value and the jul 35 call sold having $100 in intrinsic value. the spread would then have a net value of $5 (the difference in strike price). deducting the debit taken when he placed the trade, his net profit is $300. this is also his maximum possible profit.

if the stock had rallied to $42 instead, both options expire worthless, and the options trader loses the entire debit of $200 taken to enter the trade. this is also the maximum possible loss.

note: while we have covered the use of this strategy with reference to stock options, the bear put spread is equally applicable using etf options, index options as well as options on futures.

commissions

for ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

however, for active traders, commissions can eat up a sizable portion of their profits in the long run. if you trade options actively, it is wise to look for a low commissions broker. traders who trade large number of contracts in each trade should check out optionshouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).

vertical bear spreads

the vertical bear spread is a vertical spread in which options with a lower striking price are sold and options with a higher striking price are purchased. depending on whether calls or puts are used, the vertical bear spread can be entered with a net credit or a net debit.
vertical bear credit spread

a vertical bear spread can be established for a net credit if call options are used. the strategy is also known as the bear call spread.
click on the pay-off diagram to learn more about the bear call spread strategy.
bear call spread
vertical bear debit spread

a vertical bear spread can be established for a net debit if put options are used. the strategy is also known as the bear put spread.
click on the pay-off diagram to learn more about the bear put spread strategy.
bear put spread
horizontal & diagonal bear spreads

the bear calendar spread and the diagonal bear spread are both time spread strategies used by option traders who believe that the price of the underlying security will remain stable in the near term but will eventually fall in the long term.a bear spread is an option spread strategy used by the option trader who is expecting the price of the underlying security to fall.
vertical bear spreads

the vertical bear spread is a vertical spread in which options with a lower striking price are sold and options with a higher striking price are purchased. depending on whether calls or puts are used, the vertical bear spread can be entered with a net credit or a net debit.
vertical bear credit spread

a vertical bear spread can be established for a net credit if call options are used. the strategy is also known as the bear call spread.
click on the pay-off diagram to learn more about the bear call spread strategy.
bear call spread
vertical bear debit spread

a vertical bear spread can be established for a net debit if put options are used. the strategy is also known as the bear put spread.
click on the pay-off diagram to learn more about the bear put spread strategy.
bear put spread
horizontal & diagonal bear spreads

the bear calendar spread and the diagonal bear spread are both time spread strategies used by option traders who believe that the price of the underlying security will remain stable in the near term but will eventually fall in the long term.

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