Last week we discussed the basics of a bull call spread. The name of this strategy tells us a lot. First, it is bullish and second it uses calls. We know that if we are bullish on a stock we can buy calls. Thus, a bull call spread is a debit strategy that benefits from a rise in the underlying security. However, if the underlying doesn’t move or falls, a bull call spread will lose part or all of its value. Maybe we want to take the opposite side of a purchased call, expecting the underlying to react neutral or bearish. We could sell a call, but this leaves us with a naked position. Meaning that we have unlimited risk as the underlying moves higher. However, there is a way to benefit from sideways or downward movement of a stock and this is by using a bear call spread.

As the name insinuates, we will be using calls, but in a bearish nature. This means that the strategy is a credit spread. For example, let’s say we feel the XYZ stock is running into resistance at $50 and we do not expect it to rise past this point. By entering a bear call spread using the 50 and 55 calls, we can receive a credit that we are able to keep as long as the stock does not move above $50 per share. A bear call spread has a similar risk graph as a bear put spread.

Figure 1: Risk Graph of Bear Call Spread

Though the risk graph is similar, there are some major differences between the two strategies. When we enter a bear put spread, we want to have a reward-to-risk ratio of at least 2-to-1. However, this is not reasonable for a bear call spread. This is because the odds of success are much higher with a credit spread, which means the reward-to-risk will be lower. In fact, the risk associated with a bear call spread is often two to three times more than the credit received. However, we should win at least 67 percent of these trades.

This statistic is found using basic math. A stock has three ways it can move: up, down and sideways. If we enter an ATM bear call spread, we keep the entire credit as long as the stock moves in two or the three directions. This should happen two thirds of the time, or 67 percent. We should be able to increase our odds by using technical analysis and the proper options.

Overall, credit spread work best when the sold option is showing high implied volatility. It also is a strategy that takes advantage of time decay, so we normally enter a bear call spread with less than 45 day until expiration. The Optionetics Platinum site has several tools to help traders find good credit spreads, so take advantage of these if you have the program.


Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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