A bear call spread is a type of vertical spread, meaning that two options within the same expiry month are being traded.
One call option is being sold, which generates a credit for the trader. Another call option is bought to provide protection against an adverse move.
The sold call is always closer to the stock price than the bought call.
As the name suggests, this trade does best when the stock declines after the trade is open.
However, there can be many cases where this trade can make a profit if the stock stays flat and even if it rises slightly.
Bear call spreads are risk defined trades. There are no naked options here, so they can be traded in retirement accounts such as an IRA.
Traders should have a bearish outlook on the stock and ideally look to enter when the stock has a high implied volatility rank.
Two stocks came up on my screens today as possible bear call spread candidates.
Enphase Energy (ENPH) is trading below declining 21, 50 and 200-day moving averages.
ENPH stock is rated an 88% Sell with a strongest short term outlook on maintaining the current direction.
Looking at the chart there are plenty of areas of potential resistance around 120 to 130.
Enphase Energy, Inc. is a global energy technology company that delivers energy management technology for the solar industry.
It designs, develops, manufactures and sells home energy solutions, which connect energy generation, storage and control and communications management on one intelligent platform.
The company's IQ platform is the current generation integrated solar, storage and energy management offering, which enables self-consumption and delivers its core value proposition of yielding more energy, simplifying design and installation and improving system uptime and reliability.
The Enphase Home Energy Solution with IQ uses a single technology platform for seamless management of the whole solution, enabling rapid commissioning with the Installer Toolkit; consumption monitoring with Envoy Communications Gateway with IQ Combiner, Enphase Enlighten, a cloud-based energy management platform and Enphase AC Battery.
It also produces the world's only truly integrated solar-plus-storage solution.
Implied volatility is moderate at around 57%. The twelve-month low for implied volatility is 42% and the twelve month high is 86%. The IV Percentile is 43%.
Let’s look at how a bear call spread trade might be set up on Enphase Energy stock.
ENPH Bear Call Spread: June 130 – 135 Bear Call Spread
As a reminder, A bear call spread is a defined risk option strategy that profits if the stock closes below the short strike at expiry.
To execute a bear call spread an investor would sell an out-of-the-money call and then buy a further out-of-the-money call.
This bear call spread trade was found using the bear call spread screener and involves selling the June expiry 130 strike call and buying the 135 strike call.
Selling this spread results in a credit of around $0.55 or $55 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
5 – 0.55 x 100 = $445.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 12.3%.
The spread will achieve the maximum profit if ENPH closes below 130 on June 21, in which case the entire spread would expire worthless allowing the premium seller to keep the $55 option premium.
The maximum loss will occur if ENPH closes above 135 on June 21, which would see the premium seller lose $445 on the trade.
The breakeven point for the bear call Spread is 130.555 which is calculated as 130 plus the $0.55 option premium per contract.
Let’s look at another idea, this time on Taiwan Semiconductor (TSM) which was another stock that came up on my bearish scans.
TSM Bear Call Spread: June 155 – 160 Bear Call Spread
This bear call spread trade also involves using the June expiration on TSM and selling the 155-160 call spread.
Selling this spread results in a credit of around $0.50 or $50 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
10 – 0.50 x 100 = $450.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 11.11%.
The spread will achieve the maximum profit if TSM closes below 155 on June 21, in which case the entire spread would expire worthless allowing the premium seller to keep the $50 option premium.
The maximum loss will occur if TSM closes above 160 on June 21, which would see the premium seller lose $450 on the trade.
The breakeven point for the Bear call Spread is 155.50 which is calculated as 150 plus the $0.50 option premium per contract.
Mitigating Risk
With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.
For the ENPH bear call spread, I would set a stop loss if the stock traded above 125.
For the TSM trade, I would close for a loss if the stock broke through 150.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
