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hey everyone Chris here for project
option and in this options trading
strategies video we're going to talk
about the bear call spread now the bear
call spread is the combination of a
short call and a long call so to
construct a bear call spread you're
going to sell a call option at one
strike price and you're going to buy
another call option at a higher strike
price so let's go ahead and get into the
general strategy characteristics for the
bear call spread so the sale of a call
spread is also sometimes referred to as
a short call spread a bear call spread
or a call credit spread now this is a
bearish position that consists of
selling a call option while also buying
another call option at a higher strike
price the strategy builds on a short
call position by limiting the risk with
the long call so if you are bearish on a
stock and you don't want to short the
stock or sell a naked call you could
sell a bear call spread as that will
give you a bearish exposure to the stock
but you'll have significantly less lost
potential than selling shares of stock
outright or selling a naked call so the
maximum profit potential of a bear call
spread is the credit received times 100
now the maximum lost potential of a bear
call spread is the width of the call
strikes minus the credit received times
100 now the expiration break-even price
of a bear call spread is the short calls
strike price plus the credit received so
that credit helps you out now the
estimated probability of profit for a
bear call spread is greater than 50% for
out-of-the-money spreads approximately
50% for a Simoni spreads and less than
50% for in-the-money spreads now we'll
go over some examples to show you what
that really means
now after expiration if both options are
in the money then no stock position is
taken because the assignment of the
short call and the exercise of the long
call both offset and essentially what
happens is that the short call spread
just expires to its intrinsic value
you and no stock position is taken
however if only the short call is in the
money at expiration the position will
expire to negative 100 shares of stock
per short call contract so essentially I
have a short stock position of 100
shares with your sale price being the
short calls strike price now in regards
to assignment risk if the short call is
in the money before expiration there's
potential for early assignment of
negative 100 shares of stock / short
call contract so now that you know the
general strategy characteristics let's
go ahead and look at a hypothetical bear
call spread example and look at the
expiration risk profile graph so here we
see we have some various strike prices
and corresponding call option prices
based on those strikes so at the time of
these option prices let's say the stock
price is at $300 and we want to take a
bearish stance on the stock and sell a
bear call spread so to do this we're
going to sell the 310 call for $8.00 and
we're going to buy the 320 call for $5
so our net credit in this example is
going to be $3 since we're receiving $8
for the short 310 call and we're paying
$5 for the long 320 call so let's go
ahead and take a look at the expiration
risk profile graph for this position so
as you can see here our short call
strike price is 310 our long column
strike price is 320 and our breakeven
price is 313 now that's because we sold
the 310 320 call spread for a net credit
of $3 and our breakeven price is going
to be the short call strike price plus
the $3 credit which becomes out to 313
dollars so as we can see here the stock
price and entry is at $300 which will
leave us with a full profit of $300 if
the stock price remains unchanged or
even rises as much as $10 now that's
because at any price below 310 the 310
and 320 call will both expire worthless
and since we collected a net $3 credit
for that spread we'll keep these 300
dollars of premium so if the stock price
is 3
13 at expiration that short 310 call is
going to be worth $3 at expiration and
the long call is going to expire
worthless so the net value of the spread
at expiration if the stock price is at
3:13 is $3 now since we sold the spread
for a $3 credit that leaves us with no
profits or losses not including
commissions now if the stock price rises
to 320 the spread will be worth $10 at
expiration now that will happen to the
stock prices at or above 320 so as you
can see here we have a capped loss
potential of $700 and that's because if
the spread is worth $10 at expiration
we're going to have a loss of seven
dollars per spread because we sold the
spread for three dollars and that comes
out to a maximum loss per spread of $700
so unlike a short call position where
the losses keep getting larger and
larger as the stock price increases a
short call spread has a defined loss
potential now in regards to the
probability of profit this spread has a
greater than 50% probability of profit
and that's because this is an out of the
money call spread now it's out of the
money because of the short call and long
call are both above the stock price so
since the stock price is at 300 and we
sold the 310 320 call spread the
probability of profit is greater than
50% because the stock price can rise as
much as 13 dollars and we won't lose
money on this trade so as long as the
stock price stays the same decreases or
even increases slightly we can still
make money on this position now
another confirmation of the spreads
higher probability of profit is the fact
that we can only make $300 on the trade
but we can lose as much as $700 so since
our loss potential is more than twice
our profit potential this spread has a
higher probability of profit so now that
you've seen the expiration risk profile
graph let's go ahead and take a look at
some real bear call spread examples to
show you how the position performs as
the stock price changes through time
alright so example number one is a bear
call spread versus a falling stock price
so here's the set up the initial stock
price is 1 1924 and our bear call spread
is going to be constructed by selling
the 120 call for 3 dollars and 43 cents
and buying the 125 call for 850
now both options expire in 39 days and
this is a five dollar wide short call
spread so our net credit received in
this case is going to be a dollar ninety
three and that's because we collected
three dollars and forty three cents for
the 120 call and we paid a dollar 50 for
the 125 call now with a net credit of
193 our breakeven price is going to be
the short calls strike price of 120 plus
the 193 credit which comes out to 120
193 now our maximum profit potential is
if the spread expires worthless in which
case we'll keep the 193 credit and in
actual dollar terms that will translate
to a profit of 193 dollars now our
maximum loss potential is going to be
three hundred and seven dollars and
that's because we sold a five dollar
wide call spread for one dollar 93 cents
and if that spread is worth five dollars
at expiration or its maximum value we're
going to lose 317 or 307 dollars so that
comes from the five dollar wide call
strikes less the 193 credit times 100
which comes out to 307 so let's go ahead
and see how this position performed as
the stock price change through time
alright so example trade number one so
we can see that the stock price starts
right around one hundred and twenty
dollars and we know that we're short the
one twenty call and long the 125 call
and our breakeven price is 120 193 now
as we can see here as time passes the
stock price decreases and then kind of
increases back to our short column
strike price of 120 but then ultimately
ends up below 115 dollars at expiration
so as we can see here as time passes and
the stock price is decreasing the bear
call spreads value is also decreasing so
at expiration the short 120 call and the
short 125 call expire completely
worthless because they are out of the
money and therefore we keep the entire
credit of one dollar and 93 cents which
comes out to a profit per spread of a
hundred and ninety-three dollars so this
goes to show that if you sell a call
spread and the stock price remains below
your short call strike price through
expiration you're going to you're going
to experience steady profits and you
will experience the maximum profit
potential at expiration
alright so example number two we're
going to look at example where the stock
price plummets after a bear call spread
is initiated so here's the set up the
initial stock price is 400 192 and we're
going to sell the 405 call for 1983
cents and we're going to buy the 445
call for six dollars and 53 cents now
both options are expiring in 73 days now
in this case our net credit is $13.30
which brings our breakeven price to the
short call strike price of 405 plus the
net credit of 1330
which comes out to for 1830 now our
maximum profit potential in this case is
the credit of 1330 times 100 which comes
out to 1330 dollars now our maximum loss
potential in this case is two thousand
six hundred and seventy dollars and
that's because we sold a $40.00 wide
call spread we collected $13.30 for it
so if the spreads value goes to $40 will
lose two thousand six hundred and
seventy nine
/ spread so let's go ahead and see what
happens to this spread over time as the
stock price is changing alright so in
this example we can see that the stock
price starts right around four hundred
and five dollars and we're short the 405
for forty-five call spread for a total
credit of $13.30 so as we can see here
with around fifty one days to expiration
the stock price is right around our
short call strike price of 405 however
the stock price ends up plummeting to
around 350 dollars and as we can see the
value of the spread drops from right
around $13.30 to right around zero
dollars so even with 50 days to
expiration this spread is essentially
worthless because the stock price
decreased significantly now in this case
since the spread is basically worthless
and we have 50 days to expiration it
makes sense to buy back this short call
spread because you have essentially
nothing left to gain but you can still
lose the maximum value of the spread if
the stock price rallies back and ends up
above the long call strike of 1 or 445
at expiration so this is a great example
that shows you if you have a significant
stock price decrease while you're short
a call spread you can very well achieve
the maximum profit potential with plenty
of time to spare before expiration in
which case it's always advisable to go
ahead and close the spread because you
basically have nothing left to gain but
everything left to lose all right so now
that we've seen some winning trades
let's go ahead and take a look at a
losing short call spread so here is the
setup the initial stock price is 598 50
and we're going to sell the 635 705 call
spread and we're going to collect 16.9
35 cents for the 635 call and we're
going to pay $2.99 for the 705 call now
both options expire in 49 days and our
net credit in this case is $13.30
so our breakeven price is going to be
the short call strike price of six
thirty five plus the thirteen thirty six
credit which comes out to 648 thirty six
now our maximum profit potential in this
case is the net credit of 1336 times 100
which comes out to thirteen hundred and
thirty six dollars so since we have a
seventy why $70 why'd a short call
spread in this case our maximum loss
potential is going to be $70 minus the
credit of 13 36 times 100 which comes
out to five thousand six hundred and
sixty four dollars so as we can see here
our loss potential is significantly more
than a profit potential which means this
spread has a higher than fifty percent
probability of making money so let's go
ahead and see what happens as the stock
price is changing through time so as we
can see here the stock price started
right around six hundred dollars and we
were short to 635 705 call spread so
unfortunately in this case the stock
price was increasing steadily over time
and as we can see the price of the 635
705 call spread was increasing as well
now when you sell a spread you want its
price to decrease so naturally when the
stock when the spreads price was
increasing we have losses so at
expiration the stock price was right
around 705 and this spread was almost
entirely in the money now that means the
spreads value was right around 70
dollars because since the spreads strike
width is $70 the most it can be worth is
$70 so since we sold the spread for
$13.30 pation we would lose the maximum
loss potential of five thousand six
hundred and sixty four dollars so this
is just an example that shows if you
sell a call spread and the stock price
increases significantly and your short
call spread is entirely in the money at
expiration you're going to lose the
maximum loss potential because that
spreads price is going to increase
towards its strike width
now in this particular example the short
call is in the money at expiration and
long one third long 705 call is actually
just barely out of the money so that
means the long call would expire
worthless but if you held the short call
through expiration you would be assigned
a hundred shares of short stock at 635
dollars
sher so just keep in mind that if you
have a short call spread where only the
short call is in the money at expiration
you're going to take on a short call
position if you don't close that spread
so let's go ahead and recap the summary
of main concepts from this video so
first and foremost selling call spreads
is a strategy used by traders with a
bearish outlook on a stock but don't
want all the risk of shorting shares or
selling a naked call so a short call
spread is a more conservative strategy
compared to shorting shares of stock or
selling a short or naked call so selling
a call spread has limited profit and
loss potential making it a much more
conservative strategy than shorting
shares or selling they could calls and a
trader who sells a call spread benefits
from decreases in the stock price or
implied volatility and the decay of the
spreads extrinsic value as time passes
when it's out of the money so if you
sell an out of the money call spread you
really have more than one way to make
money and therefore the probability of
profit on that trade is generally
greater than 50% now to close a short
call spread before expiration simply buy
back the short call and sell the long
call at their current prices to lock in
profits or losses now this can be done
in one transaction now if a trader holds
a short call a short in the money call
spread through expiration the trader
will not end up with stocks since the
short call assignment and the long call
exercise completely offset however if
only the short call expires in-the-money
the resulting position will be negative
100 shares of stock / short call
contract so keep a knot keep an eye on
that short call spread into expiration
because if only the short call is in the
money you'll end up with a short stock
position
well thank you so much for watching this
video everybody I hope you learn
something new if you enjoyed this video
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you