Order Entry: Net Credit
Ideal Environment: High IV
Profit Target: 50%
Definition: A bearish call spread consists of simultaneously selling an OTM call (lower strike) and buying an OTM call (higher strike). The net premium collected is the result of selling the more expensive OTM call that is closer to ITM compared to the OTM call bought that is further away from being ITM. The trade results in a bearish credit position. The trade is defined risk, meaning the max profit and loss are known when the trade is placed.
Bearish Call Spread Setup
Sell 1 OTM Call (closer to ATM)
Buy 1 OTM Call (further from ATM)
The max profit for a bearish call spread is the net credit received when the trade is put on. The best case scenario is that all the options expire worthless. This happens when the market price of the underlying asset is below the lower strike call at expiration.
Max Profit= Net Premium Received - Commissions Paid
To calculate the breakeven stock price for the trade, use the following formula:
Breakeven Stock Price = Short Call Strike Price + Premium Collected
If the stock price rises above the long call strike price at the expiration date, the trade undergoes a max loss.
Max Loss = Width of the Call Strikes – Premium Collected
Suppose stock ABC is trading at $50 in June. An options trader bearish on ABC decides to enter a bear put spread position by selling a July 53 call and buying a July 55 call at the same time, resulting in a net credit of $80 for entering this position.
The price of ABC stock subsequently drops to $49 at expiration. Both calls expire worthless because none of them are in the money. This is the maximum possible profit for the trade.
If the stock had rallied to $55 instead, both options are in the money, and the options trader loses $120 on the trade. The 53 July call is $200 ITM, so that is a loss since you sold it when entering the trade. The 55 July call that was bought doesn’t have any intrinsic value. When you net out the $200 loss on the 53 call with the $80 credit received at the beginning of the trade, the result is a loss of $120. This is an example of the maximum possible loss.
When to use a bearish call spread strategy?
At Tradezy, we recommend to use this strategy for stocks with a high implied volatility. The trader should have a short to intermediate bearish thesis. We look to buy the spread position that has around 45 DTE with a 66% probability of profit. We are looking to collect about 1/3 of the width of the strikes. The goal is to sell this spread back for 50% of max profit.