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Bear Call Spread | How Does Bear Call Spread Work ?

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Simple Understanding 

One short call with a low specified price and one long call with a high starting price make up a bear call Spread. Both calls are on the same stock and expire on the same date. For a net credit, a bear call Spread is formed to profit from either a falling stock price or time expiration. If the stock price increases over the strike price of the long call, the possible profit or loss is restricted to the net premium received less commissions. 

“There is a low risk and limited profit to a bear call Spread, which is made using a short call option and a long call option.”

Bear Call Spread with an Example

Suppose, you sell some A-150 calls at the high strike price of INR 5.2 and on the other hand you also buy some A-160 calls at lowest strike price of INR 3.8, then the net credit amount for the same would be INR 1.4/-.

How both gain and loss occurred as a result of using this technique Profit/Loss

Possible gains and losses from this technique are very small and clear. Investing in this technique, an investor may expect to make up to the original net credit in profit. If the stock is trading above the lower strike price when the option expires, then profits will begin to decrease, while losses will reach their maximum if the stock is trading above the specified price. 

Short-call losses are totally offset by long-call gains above the higher target level. How the investor chooses the two futures price ultimately decides how much money he or she can make and how much risk he or she is willing to take. The starting net premium income of the investor might be increased if the investor chooses a short call strike that is lower and/or a long call strike that is higher.

  • The greatest possible profit will be restricted to the net premium earned at the beginning of the deal.
  • There will be a maximum loss of the net premium earned at the outset divided by the difference between the two strike prices.

Taking a Bear Call Credit Spread Position / Entry Strategy

You can use this strategy to purchase and sell options with the same expiration date if you’re looking for an opportunity to profit from the bearish trend.

A credit will be issued as a consequence of this action. Purchasing the higher call option will result in a lower total premium collected to start the transaction; but, it will define the position’s risk as the Spread of the wide minus the credit that was earned.

Exit Strategy

  • Hold on to your premium until your options expire. You should reverse your position by purchasing back the call option that you just sold and selling the call option that you just bought. 
  • When you want to get out of a bear call credit Spread, you have to buy the option to close the short call position, but you have to sell the option to close the long call position. 
  • A profit can be made by purchasing the Spread at a price that is lower than the price at which it was sold. If at the time of expiration the stock price is lower than the strike price of the short call option, then both options will expire worthless, and the whole credit will be considered earned revenue. 
  • At the time of expiration, if the stock price is higher than the long call option, then the two contracts will cancel each other out, and the position will be terminated with the maximum possible loss.

If you’re looking for a technique with a lower risk but a smaller reward, then one this is the best technical you can practice for sure. Investors who anticipate a little decline in the underlying asset’s price will often employ this trading method in their trades. This results in increased credit while simultaneously lowering the total amount of risk. The increased Spread provides some compensation for the position that was lost initially.

Conclusion

Since this is a very technical concept, we tried to explain it to you in a theoretical way. Please learn the basics of the market before you make any decisions. 

With one short and one long call option, the bear call Spread is a low-risk, low-reward strategy. In most cases, this technique pays well if the stock price stays the same or drops. The maximum amount it can produce is the first net premium received. Long call limits losses if projection is wrong and stock rebounds instead of falling.

The risk of bear call credit Spreads can be mitigated by hedging the position. You can open an opposite bull put credit Spread with the same breadth and expiration date if stock prices have gone higher. 

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