Bear Call Spread
Risk: low
Reward: low
General Description
Entering a bear call spread position typically entails selling at-the-money calls and buying out-of-the-money calls.
The Thinking
This strategy is employed when you are generally bearish but want a little upside protection. Essentially you are selling naked calls but then protecting yourself by buying out-of-the-money calls just in case the stock rallies.
Example
Let's say QQQQ is trading @ 30.11. You are bearish and think the stock will fall, but want some upside protection just in case it doesn't. Sell the 30 calls (you are naked); then buy the 32 calls for some upside protection.
If the stock drops below 30 as you expect all calls (long and short) will expire worthless and you will profit because the premium collected from selling the 30 calls was greater than what you paid for the 32 calls. Your max loss occurs at 32 where the 30 calls will have to be bought back at a higher price than what you paid and 32 calls expire worthless. Above 32, the long and short calls will cancel each other out.
The image below summarizes the trade with a P/L Diagram. |
