Bear Spreads

While the bull spread seeks increases in market value, the bear spread will produce profits if the stock's market value falls. In this variety of the spread, the higher-value option is always bought, and the lower-value option is always sold.


A Bearish Idea: You open a bear spread using calls. You sell one March 35 call and buy one March 40 call. The stock's market value is $37 per share. The premium value of the lower call, which is in the money, will decline point for point as the stock's market value falls; if the stock's value does fall, the position can be closed at a profit.


Going Pessimistic with Puts: You open a bear spread using puts.
As shown in the example in Figure below, you sell one December 50 put and buy one December 55 put. The underlying stock's market value is $55 per share. As the price of the stock moves down, the long 55 put will increase in value point for point with the change in stock price. By the time the stock's price moves down to $51, both puts will be profitable -- the long put from increased intrinsic value, and the short put from lower time value.

[caption id="attachment_12548" align="aligncenter" width="460"]Example of bear spread. Example of bear spread.[/caption]

This scenario assumes ideal conditions in which the stock's price moves the desired number of points in the perfect time frame, which enables the bear spread writer to profit. The example illustrates the ideal outcome using a bear spread. You gain more flexibility when going long using LEAPS options in the bear spread; this enables you to write several short-term puts against the "covered" longer position. The cost for the long position will be greater due to the time factor, but the potential for profit makes the entire strategy far more flexible as well.

Smart Investor Tip

Bear strategies often are overlooked, because people tend to be optimists. Look at all of the possibilities. You can make money when the stock goes down in value, too.

A detailed bear spread with defined profit and loss zones is illustrated in Figure below.

[caption id="attachment_12549" align="aligncenter" width="300"]Bear vertical spread profit and loss zones. Bear vertical spread profit and loss zones.[/caption]


Profits on Both Sides: You sell one September 40 call for 5 and buy one September 45 call for 2; your net proceeds are $300. As the stock's market value falls below the level of $45 per share, the short 40 call will lose point value matching the stock's decline; the long call will not react in the same way, as it remains out of the money. As the $40 per share price level is approached, the spread can be closed with profits on both sides.

Consider how the preceding example would work with puts instead of calls. In that scenario, the long put would increase point for point with a decline in the stock's market value.

When the bear spread employs calls, profits are frozen once both sides are in the money, at least to the degree that intrinsic value changes; one side's increase will be offset by the other side's decrease. The only remaining opportunity to increase profits at that point would lie in time value premium left in the short position.

In all of these examples, the most significant risk is that the stock will move in the direction opposite that desired. Be prepared to cut losses by closing a spread in that event before the short position increases to value. You risk exercise on the short side at any time that option is in the money, and you might need to close to avoid exercise. Your maximum risk other than that of exercise is limited to the point difference between the two striking prices (minus net premium received when the position was opened, or plus net premium paid). In the preceding examples, a five-point spread was used, so that maximum point-spread risk is $500. The point-spread risk increases as the gap between striking prices changes, as shown in Table below.

Spread Risk Table

Striking Price Interval
Number of Option Spreads5 Points10 Points


Limiting the Risk Zone: You open a spread. The difference between striking prices on either side is five points. Your maximum risk is $500 plus trading fees, plus net premium paid when you opened the position (or minus net premium received).


A Four-Part Position: You open a spread buying and selling four options on either side. The difference between striking prices is five points. Your maximum risk is $2,000 (modified as in the previous example), because four positions are involved, each with a five-point difference between striking prices.

By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2016. Content published with author's permission.

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