Making Money If You Have A Neutral To Bearish Outlook

A Bear Call Spread is used when you have a neutral to negative view on a stock.

While this strategy has a limited risk, it also has a limited reward.

So if you’re expecting a big down move to occur, you’d be better off looking at a more aggressive bearish strategy that affords unlimited profit potential.

But for this strategy, a neutral (or choppy) to bearish outlook can make the Bear Call Spread a great strategy to use.

Definition

A Bear Call Spread is when you sell a closer-to-the-money strike (usually an at-the-money strike) and buy a further out-of-the-money strike.

This strategy is put on as a credit, which is why it’s often referred to as a Credit Spread.

The reason it’s called a Credit Spread is because if you write a nearby strike and buy a further out strike, you’d collect more on the nearby option you wrote and spend less on the call that you bought, thus resulting in a credit to your account.

This can also be done with puts as well. But today we’ll focus on the calls.

Example

Let’s say stock XYZ was trading at $50:

• You write the October $50 Call for 5.00 and collect $500 
• You also buy the October $55 Call for 3.00 meaning you spend $300
————————————————-
• Net ‘cost’ (credit) = $200
(i.e., collect $500 for the short $50 call, less the $300 spent for the long $55 call and that equals a credit of $200)

How Do I Win and How Do I Lose?

Your maximum potential profit will be the credit you collected when you put this trade on. And your maximum profit potential will come if the stock closes below the lowest strike price at expiration – in this case the $50 call.

Why?

Let’s look at each component of the spread individually.

• If the price of the stock stays at $50 or lower at expiration, the $50 call option you wrote for $500 will expire worthless meaning you’d keep the entire $500 premium you collected. 
• The $55 call you purchased for $300 will also expire worthless meaning you’d lose the entire $300 you paid.
—————————————————————————–
• But remember, you collected $500 and lost -$300 meaning you ended up keeping the entire credit of $200 — which is your profit.