How does a Bear Call Spread work?

A Bear Call Spread is one way to make money as the stock market goes down. It allows you to make money as a stock goes down, sideways or even up a little.

It works by buying a call and selling another call with a lower strike price on the same stock. The difference between what we bought the higher strike priced call for and what we sold the lower strike pricked call for is the premium we made. We would make this as long as the stock stays below a certain level.

Now let’s look at an example. We have found a stock that is in a downtrend. We also believe it will go down even further in the future. Combined with this is the fact that the stock is hitting resistance at $69.

We have an overall bearish stance on this stock, so what can we do. If we shorted the stock or bought a put option we would only make money if the stock does in fact go down further.

However if we place a bear call spread we are going to have a higher chance of making money because we are not asking the stock to do much.

We can decide to buy the $75 call for $1 and sell the $70 call for $2.50. From this sort of a trade we walk away with $1.50. As long as the stock stays below $70 we would be profitable here. The only problem is if the stock decides to turn against us we could potentially lose money.

But our max loss will be limited to the difference between the spread minus the premium we made. In this case the most we could possible lose if the stock started to skyrocket is $3.5 ($5-$1.5).

Sometimes the higher probability makes you take lower risk to reward ratios. This is ok; just make sure it makes sense. You should have your own rules on the minimum premium you will accept.

Personally I do not like to enter a bear call spread if I will get less than 20% of the spread. So if the spread is $5, I want to make at least $1.

But everyone is different. You should decide the minimum money you are willing to take based off things like, how far out of the money you are going to sell and how often you are right.