What Is a Bear Call Spread? How It Works

By Samuel Becker · February 22, 2022 · 5 minute read

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What Is a Bear Call Spread? How It Works

Like other aggressively-named options trading strategies, the bear call spread has more to do with numbers and market timing than it does with fur and fangs (or horns). But it’s yet another options trading strategy that can help you beef up your returns.

If you’re an options trader — or an aspiring one — you likely know many of the common strategies for trading options, including calls, puts, and bull put spreads.

But options strategies can get very complicated, very fast — and the bear call spread is no different. Here’s what to know about the bear call spread and how it works.

What is a Bear Call Spread?

A bear call spread is one of four basic vertical options spreads that traders put to regular use. It is the opposite of a bull call spread, and it’s particularly useful if you’re anticipating a bear market.

A trader utilizing a bear call spread strategy is trying to capitalize on a decrease in value of the option’s underlying asset. Hence, the “bear” in the strategy’s name. And as such, a trader would use a bear call spread only in the instance that they believed the underlying asset’s value was going to fall.

How Does a Bear Call Spread Work?

A trader creates a spread by buying and selling two call options at the same time, attached to the same underlying asset, with the same expiration date. The key difference is that the two call options have different strike prices. One call option one is a long call option strategy, and the other is short (similar to shorting a stock), with the short call having a lower strike price than the long call.

When the trader simultaneously purchases a long call and sells a short call (with a lower strike price), it creates a credit in the trader’s account, since the calls the trader is buying are less expensive than the calls the trader is selling. The short call generates income for the trader by creating a premium, and the long call helps limit the trader’s risk.

Setting up these two positions creates a spread, and the trader benefits when the underlying asset’s value declines. The maximum potential profit is capped at the value of the premium received.

If the underlying asset’s value increases, the spread can become a loser for the trader — but that maximum potential loss is capped at the difference between the strike prices of the two options, minus the premium.

Example of a Bear Call Spread Strategy

As an example, in its simplest form a bear call spread could involve a trader selling a short call option on stock XYZ, which expires in one month, with a strike price of $10, for a premium of $2. Simultaneously, they buy a call option with the same expiration and a strike price of $12 for a premium of $1. By selling the short calls, they’ve received a net premium of $1. Since an option contract typically controls 100 shares, their total credit is $100.

With that, a bear call spread has been set up. The trader has two calls with the same expiration date, but two different strike prices. The short call’s strike price is less than the long call’s strike price.

To continue this example, let’s say a month goes by, and the trader’s bearish instincts have proven correct. Stock XYZ’s price declines and their call options expire below the $10 strike price of the short call. They keep the net premium of $100, and walk away with a profit.

We should also consider the downside scenario where the stock price does not move in the trader’s favor. Suppose instead that XYZ climbs to $13 on expiration day. The trader closes out both contracts for a net loss of $2 per share, or $200 for each set of contracts. This is offset by the $100 they received upfront, so their net loss is just $100.

Finally, let’s analyze the breakeven point. This will occur at the strike price of the short call, plus the net premium received. In our example, the $10 lower strike, plus $1 of net premium, or $11.

Advantages & Disadvantages of a Bear Call Spread

Advantages

Disadvantages

Flexibility Capped potential gains
Capped potential losses Limited potential use
Relative simplicity The strategy could backfire completely

Advantages of a Bear Call Spread

There are some advantages to bear call spreads, which is why some traders use them to pad their returns.

•   Flexibility: There is a lot of wiggle room for traders in how they set up the strategy. Depending on the specific calls sold and purchased, traders can see a profit under a variety of scenarios, such as when the underlying asset’s value remains the same, or when it declines.

•   Capped potential losses: There’s a maximum that a trader can lose, and that can be comforting to some. These types of strategies are used not only to increase profits, but to limit risk, and limiting risk can be a very attractive attribute in a volatile market.

•   Relative simplicity: When you think about it, traders are really just making two transactions: Buying a call option, and selling another. Given that other options trading strategies involve even more moving parts, the fact that a bear call spread only requires two moves at the onset can be advantageous to some traders.

Disadvantages of a Bear Call Spread

Bear call spreads can have their disadvantages.

•   Capped potential gains. Like other vertical spread strategies, potential gains are capped — in this case, at the initial net premium credited to the account.

•   Limited potential use. The strategy is best used when dealing with assets that are volatile and that may experience a decline in value. It’s hard to say when, or if, the right market conditions and an appropriate asset align in such a way that a trader would use the strategy to profit.

•   The strategy could backfire completely. The risk is that the underlying asset sees a dramatic rise in value, rather than a fall in value, as the trader predicted, blowing up their short call. This could mean that the trader has to buy the underlying asset at market value, potentially leading to a loss.

Bear Call Spread Considerations and Tips

There are a few other things worth keeping in mind when it comes to the bear call spread strategy.

•   There’s an early assignment risk. Since options can be exercised at any time, traders with short option positions should remember that they’re putting themselves at risk of early assignment — or, the trader needs to fulfill their obligation and may need to buy the underlying asset to do so.

•   The strategy can be used in variations. A bear call spread is only one of several vertical options spreads that traders can put to use. Depending on market conditions, it may be wise to use a bullish strategy instead.

•   This is all speculative! It’s critical to remember that options trading is speculative. There are no guarantees, and the risk of loss is real. No matter how good any trader thinks they are at predicting the market, things can go sideways at any point. It’s important for investors to calculate the risk-reward ratio before choosing their speculative tools.

The Takeaway

The bear call spread is one of many options trading strategies a trader may employ in trying to reap as much profit from their investments as possible. But as with all strategies, it is not foolproof, and positive results are never guaranteed.

Using high-level options trading strategies, like the bear call spread, can be a bit advanced for many investors. On the other hand, there are simpler investing strategies, such as building a portfolio with stocks, and ETFs — all of which are possible with the SoFi Invest® investment app.

Find out how to get started with SoFi Invest.

Photo credit: iStock/PeopleImages


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