Bear Call Spread Options Strategy
Strategy Level: Beginners
Call Options:
Positions in HDFC: 2.
Market Outlook: Bearish
Risk Profile: Limited Risk
Limited Reward: Reward Profile
The Bear Call Spread involves simultaneous action in the options markets. It entails buying one Call Option and selling another Call Option at a lower strike on the same asset. This strategy results in lower investment costs as you receive a bonus when selling the Call Option and pay a penalty when buying the Call Option. The Bear Call Spread carries a lower risk, and the rewards are limited to the difference in premiums paid versus received.
Traders use this strategy when they believe the price of HDFC, the underlying asset, may moderately decline. It is sometimes referred to as the bear credit because of the credit received when the trade was entered. The strategy effectively limits both the risks and rewards.
How to Use the Bear Call Spread Options Strategy
Here is an example of a bear call spread using HDFC, which is currently trading at Rs 10,400.
Bear Call Spread Orders – HDFC
Orders:
- Buy One OTM Call
- Buy 1 ITM Call
Imagine HDFC is trading at 10,400. We would buy one out-of-the-money HDFC option and sell one in-the-money (ITM) option.
When selling a call, the trader receives a greater premium, while buying a call results in a lesser premium payment. If HDFC drops, the trader keeps the net premium, and the maximum possible profit is determined.
The trader will lose only the difference in the strike price between the two strikes minus the premium received when the strategy was initiated.
Bear Call Spread Strategy : How to Use it?
The bear call spread option strategy is utilized when you have a negative market view. It helps reduce risk when price movements are contrary to your expectations.
Stock Option Example
Let’s take HDFC, a stock that traded at Rs 37 back in June. The following options contracts are available with premiums:
- The call for July 40th is 1 rupee.
- July 35th call is Rs 3.
One Lot of 100 shares
Purchase July 40 Calls: 100 x 1 = Rs. 100 Paid
When multiplying 100 by 2, you will receive Rs. 300.
Net credit: Rs. 100 + Rs. 300 = Rs. 200
Let’s discuss some possible scenarios.
Scenario 1: The stock price remains unchanged at Rs 37
- The July 40 call is worthless.
- July 35 is worthless.
The net premium for the call position is Rs. 200.
Total Profit = Rs. 200
The strategy allows for a maximum profit of Rs. 200, which is the premium paid when you entered the market.
Scenario 2: The stock price rises to Rs 42
- Purchase July 40 Calls Expires in-the-Money at an intrinsic value of (42-40) * 100 = Rs 200.
- Buy Calls July 35 Expires in-the-Money (35-42) * 100 = Rs 700.
The net premium is Rs. 200.
Total Loss = -Rs 700 + Rs 200 + Rs 200 (Premium Received) = -Rs 300
The maximum loss possible is shown here.
Scenario 3: The stock price goes down to Rs 30
- Same as scenario 1:
- July 40 call is worthless.
- July 35 is worthless.
The net premium for the call position is Rs. 200.
Profit = Rs. 200
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Bank Nifty Example 2
| Options Strategy – Strike Price, Premium, and Net Premium | ||||
|---|---|---|---|---|
| Strike Price (Rs) | Premium (Rs) | Total Premium Paid (Rs)(Premium * lot size 25) | ||
| Buy 1 OTM Call | 9000 | 400 | 10000 | |
| Sell 1 ITM Call | 8800 | 500 | 12500 | |
| Net Premium (500-400) | 100 | 2500 | ||
| Options Strategy – Net Profit and Net Payoff | ||||
|---|---|---|---|---|
| Options Strategy – Net Profit and Net Payoff | Net Profit from One ITM Call Sold at Rs. | Net Payoff for 1 OTM Call Bought at Rs. | Net Payoff in Rupees | |
| 8500 | 12500 | -10000 | 2500 | |
| 8700 | 12500 | -10000 | 2500 | |
| 8900 | 10000 | -10000 | 0 | |
| 9100 | 5000 | -7500 | -2500 | |
| 9300 | 0 | -2500 | -2500 | |
Market View: Bearish
If you expect that the price will moderately decline, the bear call spread option strategy can be utilized.
Actions
- Buy OTM call option
- Sell Call ITM Option
Consider that you’re bearish about HDFC and anticipate a slight decline in its price. The Bear Call Strategy allows you to buy a Call Option with a higher strike and sell it at a lower strike. When you sell a Call Option, you will receive a larger premium and pay less if you purchase a Call. The net premium will determine your profit, and if HDFC rises, your loss is the difference between strike prices less net premium.
Breakeven Point
The breakeven point is the short call strike price plus the net premium received. The strike price of the short call is the same as the break-even point.
