Bear-call credit spreads are very similar to bull-put credit spreads, except that these trades are appropriate for an underlying stock with a bearish outlook. In a bear-call credit spread, you sell a call at one strike price, and purchase another call on the same stock with the same expiration at a higher strike price for a net credit on the trade. Usually, both of these put options will be out-of-the-money when the position is established.
Depending on your account type and trading level, your broker may require that these trades be cash-secured or they may allow you to put up an existing equity position or margin as collateral. For more details about your situation, please contact your broker directly.
If the stock is below the lower strike price at expiration, then both options will expire worthless, the investor takes no further action, and the credit from the trade becomes bankable profit. That initial credit is the maximum profit on this type of trade.
The worst case for a bear-call credit spread is if the underlying stock finishes at expiration above the higher call’s strike price. In this case, the sold call will automatically be assigned, forcing us to sell the underlying stock at that strike price even though the market price for the stock is higher. The bought call will also automatically exercise, letting us buy the stock for the higher strike price. The end result is that the investor will have a net debit equal to the difference between strike prices.
In between these two cases is a middle path that happens only when the underlying stock finishes at expiration between the strike prices of the two calls. In this case, the sold call is assigned, but the bought call expires worthless. This results in a short stock position that will need to be covered by purchasing the stock at market prices as soon as possible.
Our analysts strive to exit trades that might be in trouble before expiration passes and forces our hand. To exit a bear-call spread, buy back the sold call and sell the bought call for a total debit.
A similarly-structured trade for an underlying stock with a bullish outlook is a bull-put credit spread.
InvestorsObserver analysts usually look for bear-call credit spread trades where the sold call is 10% or more out-of-the-money, so that our positions make a profit if the underlying stock falls, stays flat or even rises by a little. Trades with this amount of protection often target returns of 5-10% in just two months for annualized returns (for comparison purposes only of 30-60%.