Bear & Bull Market Option Spreads

Bear & Bull Market Option Spreads

BEAR SPREAD
A bear spread is an option strategy in which a call is purchased and a call of a lower strike on the same stock is sold. Both calls must have the same expiration date. A bear spread can also be established by using put options, in which one put is purchased and another put with a lower strike is sold. Again, both strikes must have the same expiration date. These option strategies are called "bear spreads" because they are used by traders who are bearish on a stock, yet want limited risk. Bear spreads may require higher commissions since they involve buying or selling multiple positions.

Since bear spreads are contract-neutral, (the position is short the same number of contracts it is long) the profit or loss is limited. When you buy a put bear spread, the maximum loss possible is the net amount paid. When you sell a call bear spread, the maximum loss is the strike difference, less the net premium received from the original sale. Depending on which strikes are traded, bear spreads can also be used to profit from lack of stock price movement.

Consider this example: Stock XYZ is trading at 50. An option trader sells the near-term 55 call and buys the near-term 60 call for a net credit of 100. If XYZ stays below 55 until and through expiration, the trader will realize a profit of 100. If the stock rises above 60 before expiration, the trader will realize the maximum loss of 400. This example is exclusive of commissions, interest and dividends.

BULL SPREAD
A bull spread is the opposite of a bear spread. The margin costs and risk characteristics of bull spreads are the same as those of bear spreads. Bull spreads are used when traders are bullish yet want limited risk. Like bear spreads, these strategies may require higher commissions since they involve buying or selling multiple positions.

Examples of bull spreads include buying a call and selling a call of a higher strike of the same expiration and same stock. Or, one could sell a put bull spread by selling a put and buying a put of a lower strike.

The most that can be lost in the first example (call bear spread) is the difference between the strikes, or 500, less the credit received of 270. Thus the maximum loss is 230. The maximum profit, which would occur if XYZ closed below 50 on expiration, is the credit received, or 270.

In the example of buying the put bear spread, the maximum profit is the strike difference less the premium paid, or 325. The maximum loss is the premium paid, or 175.