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.
Verizon (VZ) has been in a downtrend for a few months and is rated a 72% Sell with a strengthening short term outlook on maintaining the current direction. Long term indicators fully support a continuation of the trend.
Looking at the chart there are plenty of areas of potential resistance around $35-$36.
Verizon Communications Inc. offers communication services in the form of local phone service, long distance, wireless and data services.
In Jan 2006, Verizon completed its merger with MCI Corporation, a leader in long distance and data networking.
With the acquisition of Alltel Wireless Corp. in early 2009, Verizon has surpassed AT&T Inc. as the largest wireless carrier in the North America, serving millions of customers nationwide.
Verizon has teamed up with Amazon Web Services to create and deploy low latency applications to mobile devices using 5G and became the first telecom carrier in the world to offer such service.
The company has launched a free consumer search engine dubbed OneSearch with enhanced privacy options to add a new dimension to the search ecosystem.
It has also announced a pricing breakthrough in the cable industry with the launch of Mix & Match on its FiOS platform, enabling viewers to combine TV with Internet plans effectively without any hidden charges and annual contracts.
VZ is currently below declining 50 and 200-day moving averages and could be a good candidate for a bearish option trade.
Implied volatility is moderate at around 20%. The twelve-month low for implied volatility is 16.52% and the twelve month high is 35.94%. The IV Percentile is 15%.
Let’s look at how a bear call spread trade might be set up on VZ stock.
VZ Bear Call Spread: January $35 – $37 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.
Bearish traders could sell the January expiry $35 strike call and buy the $37 strike call.
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:
2 – 0.50 x 100 = $150.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 33 %.
The spread will achieve the maximum profit if VZ closes below $35 on January 19, 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 VZ closes above $37 on January 19, which would see the premium seller lose $150 on the trade.
The breakeven point for the bear call Spread is $35.50 which is calculated as $35 plus the $0.50 option premium per contract.
Let’s look at another idea, this time on Moderna (MRNA) which was another stock that came up on my bearish scans.
MRNA Bear Call Spread: October $115 – $120 Bear Call Spread
This bear call spread trade also involves using the October expiration on MRNA and selling the $115-$120 call spread.
Selling this spread results in a credit of around $0.85 or $85 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 – 0.85 x 100 = $415.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 20.5%.
The spread will achieve the maximum profit if MRNA closes below $115 on October 20, in which case the entire spread would expire worthless allowing the premium seller to keep the $85 option premium.
The maximum loss will occur if MRNA closes above $120 on October 20, which would see the premium seller lose $415 on the trade.
The breakeven point for the Bear call Spread is $115.85 which is calculated as $115 plus the $0.85 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 VZ bear call spread, I would set a stop loss if the stock traded above $37.
For the MRNA trade, I would close for a loss if the stock broke through $115.
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.
