Vertical bear call

Article contents



At a glance



Setting up the bear strategy


  1. Buy one call option on the underlying stock.

  2. Sell one call option on the same underlying stock with a strike price below the long call option.

Ideally you want the stock to be below the long call’s strike at expiration.

Who should run this?


Ideal for all traders, from novice to advanced.

Margin requirements


Learn more about Questrade’s option margin requirements.

Strategy overview



A vertical call spread is an option strategy in which a trader buys and sells a short and long call option of the same underlying symbol simultaneously. The call options must have identical expiration dates but different strike prices.

This strategy may be used by a trader who wants to offset the cost of purchasing the long call option by selling a short call option (bullish), or by a trader who wants to reduce their overall risk by having the higher strike as upside protection rather than selling the naked call on its own (bearish). However, keep in mind, that this also limits the potential profit.

There are two types of vertical call spreads:


Spread type
Description
Bull Used by a trader who thinks the security’s price will rise before the call options expire.

To learn more, see Vertical bull call.
Bear Used by a trader who thinks the security’s price will fall before the call options expire.


Market outlook

  • Slightly bearish

Strategy benefits


  • Reduced risk when implementing a bearish call spread by having the higher strike as upside protection rather than selling the naked call on its own.

Strategy downsides


  • Profit is limited to the premium received when implementing a bearish call spread. 

Vertical bear call example



Scenario

You believe that ABC shares currently trading at $50 will fall in the near future, so you buy a $54 long call option for $100 and sell a $45 short call option for $500. Your initial credit would be $400. 


This strategy means that you:

  • as the buyer of the call option, have the right to buy the shares at $54 before the expiration date 

  • and

  • as the seller of the call option, have the obligation to sell the shares at $54 before the expiration date if the option is exercised. 

Possible results


  1. At expiration, the stock’s price closes at $44, meaning both options expire worthless. As a result, you keep the $400 credit as profit.

  2. At expiration, the shares close at $55, meaning both options expire in the money (i.e. the strike prices – $45 and $54 – are both below the market price of the stock). 
In this case, both call options would be exercised.  The intrinsic value of the call options would be as follows: 
  • $1000 for the short call ($55 - $45 )x 100
  • $100 for the long call ($55 - $54) x 100
The spread value would be $900, leaving you with a total loss of $500 after the initial $400 credit has been applied.

Profit and loss explained



Maximum profit

  • Maximum profit = (short option premium – long option premium) x number of contracts x 100

Maximum loss

  • Maximum loss = [(strike price of long call – strike price of short call) x number of contracts x 100] – net option premium received 

Break-even at expiration

  • Break-even point = strike price of short call + short option premium – long option premium

Sample calculations



  • Stock value at start of strategy: $50
  • To execute the strategy: Buy $54 long call option for $100, Sell $45 short call option for $500
  • Result: $400 net credit
Stock price at expiration Profit and loss calculations 
$44

$5 (short call option premium)
– $1 (long call option premium)
x 1 (number of option contracts)
x 100 (number of shares)
= $400 profit


$55

$54 (strike price of long call option)
– $45 (strike price of short call option)
= $9 x 1 (number of option contracts) x 100 (number of shares) = -$900
+$400 (net option premium received)
= $500 loss 


Note
: commission fees are not included in the above calculations.


Payoff diagram






Creating a vertical bear call







Standard order details

Order detail

Description

Symbol lookup field

Click  and change the mode to , then enter the symbol you want to buy or sell.

Tip: if you don't know the symbol name, try entering the company name.

The default expiration date, strike price, and strategy appear. 



Modify the expiration date, strike price, and option strategy accordingly. For more information, see Elements of an option quote.

Action The buy or sell action is set for you when you select the strategy type.
Qty

Select a value using the arrows , or enter a value manually.

Note: by default, the quantity will be populated with the value set in your user preferences.
Order type Select the type of order you want to submit. When creating strategy orders, only Limit or Market order types are available. For more information, see Order types.

The limit order type requires you to fill in additional fields. Refer to the table section below for details.
Duration

Select a duration to specify how long the order should remain active. For more information, see Order durations.

Route Select a route or leave the selection at Auto to let the platform determine the best one. Canadian routes will be listed for Canadian symbols and U.S. routes will be listed for U.S symbols.
Sub-route

This field will be filtered according to the route selection. It indicates where you prefer the order to be executed. Leave the selection at Auto to let the platform determine the best route.

Note: sub-route selection is only available for Canadian symbols.
Account

Specify the account you want to use to submit an order. This field will display the account you have set as your default under user preferences, or the account you have selected in any of the linked windows. See Linking and unlinking windows for details.

Order type-specific details
Limit Enter your limit price:

  • To have the price fluctuate according to real-time data, click the lock   and select either Follow ask price  or Follow bid price .
  • To choose a custom price, select Do not follow .
Note: if real-time market data is not available, the limit price will be blank and the float limit icon will be unlocked.




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