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.
Fedex (FDX) suffered a huge gap down yesterday after their earnings result fell short of expectations and the company lowered their full-year sales outlook.
Many times, when a stock gaps down like this, it fails to recapture the daily high in the next few trading sessions. The high yesterday for FDX stocks was 252.68.
If we take a view that FDX stock is unlikely to get back above 252.68 in the next week or so, we can look at a bear call spread.
FDX Bear Call Spread: December 29th $255 – $260 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 December 29 expiry $255 strike call and buy the $260 strike call.
Selling this spread results in a credit of around $0.75 or $75 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 – 0.75 x 100 = $325.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 23%.
The spread will achieve the maximum profit if FDX closes below $255 on December 29, in which case the entire spread would expire worthless allowing the premium seller to keep the $75 option premium.
The maximum loss will occur if FDX closes above $260 on December 29, which would see the premium seller lose $325 on the trade.
The breakeven point for the bear call Spread is $255.75 which is calculated as $255 plus the $0.75 option premium per contract.
FDX is currently below the 21 and 50-day moving averages and could be a good candidate for a bearish option trade.
Implied volatility is moderate at around 25%. The twelve-month low for implied volatility is 20.84% and the twelve month high is 41.40%. The IV Percentile is 27%.
FedEx Corporation is the leader in global express delivery services.
The company provides a broad portfolio of transportation, e-commerce and business services through companies competing collectively, operating independently and managed collaboratively, under the FedEx brand.
The company is currently reporting, primarily through the FedEx Express (including TNT Express acquired in 2016), FedEx Ground and FedEx Freight segments.
FedEx Express offers time-definite delivery to more than 220 countries and territories, connecting markets that comprise almost the entire gross domestic product of the world.
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 FDX bear call spread, I would set a stop loss if the stock traded above $255.
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.
