Options provide a large degree of flexibility and can provide traders with a strong advantage when faced with varying market conditions. One particular strategy, the Bear Call Spread, is a strategy where a trader can profit from both sidewards and downward movement. This article will cover the key topics of how and when to apply a Bear Call Spread using a real example from our market.
These key topics are:
- What a Bear Call Spread is
- When to apply the strategy using an example
- The benefits of a Bear Call Spread
What a Bear Call Spread is:
A Bear Call Spread is a “credit spread” which means you receive a credit upon entering the trade. Subsequently, if you want to close this trade, you will have to pay to exit. The idea is to pay less that what you receive.
Options have time value which erodes as expiry approaches. The Bear Call spread can benefit from time decay, as we want our options to erode in value and therefore pay as little as possible when exiting the trade.
When to use a Bear Call spread:
A Bear Call Spread can be suitable if you have a bearish or bearish to sidewards view of the market.
For example, looking at the XJO chart, you can see the Index has been trading in a channel pattern for the past few months. The top of the channel is around 5800 and the bottom is roughly 5650.
Once the XJO nears these levels, it turns around to continue the channel pattern, making it a very predictable to trade. Its also worth Noting that the 100 day Moving Average has acted as a strong resistance as well. Today the XJO rose up towards 5800 but failed to stay above the 100 day Moving Average. This is an indication that the next move for the XJO is bearish.
This setup is ideal for implementing a Bear Call Spread as we can place the majority of our risk at or above the major resistance level of, whilst still receiving a suitable premium. If the XJO falls back towards the bottom of the range we can take profit early at around 5700.
The trade will also profit from time decay, so if the XJO takes its time to fall, we may be in opportunity to take a profit from less movement, or even hold the trade to expiry and make maximum profit.
Bear Call Spread benefits:
There are several key reasons traders might use this strategy:
It is a strategy which can profit from a falling and/ or sidewards market, where the risk is only if the market rises.
In the AMP example, The Bear Call Spread benefits from simply time passing by and can result in taking maximum profit, as long as the stock is below $6.00 on expiry. In addition, if AMP were to fall, an opportunity would also arise to close for a strong profit.
The Bear Call Spread is a credit spread, and on the Australian market you can use certain stocks to cover margin on credit spread. This often makes the Bear Call Spread an attractive strategy for increasing yield on a share portfolio.
Options are a highly flexible tool which a trader can harness to capitalise on any view they hold on the market. The Bear Call Spread is but one example of a strategy that an option trader has in their arsenal, to take advantage of any market condition.
If you would like to further understand how to implement a bear call spread, you can watch a short video buy clicking here.
If you would like to construct a Bear Call spread yourself and practise other options strategies, you can register to use the options calculator here.