Bear Spread with Call Options

The Bear Spread with Call Options involved writing a call option at lower underlying strike price K1 and buy in a call option at higher underlying strike price k2.

The assumed current underlying asset price is lower than K2.

Bear Spread with Call Options

 Bear Spread with Call Options with Lower Underlying Asset Price

Bear Spread with Call Options

Profit from Bear Spread with call options

(compute based on: volatility 54%, risk free rate on options 10%, K $45, K1 $50, K2 $55, period 6 months, present value of initial cashflow neglected, equity)

The purpose is to profit as long as underlying asset price moves below K2 after compensating for initial cash outlay represented by cost of long call option and income generated by writing call option.

Given that time to expiry is the same for both options, the higher strike price call option will be priced cheaper than the lower strike price option.

Let us assume P1 be writing price of call option with underlying strike price K1 and P2 buy-in price of call option with underlying strike price K2.

Bear Spread with Call Options

Profit Table

Initial Cash Outlay = P1-P2  (P1>>P2)

Underlying Price Range Payoff from Short Call Option at K1 strike Payoff from Long Call Option at K2 strike Total Payoffs
ST ≤ K1 0 0 P1– P2
K1 < ST < k2 K1 – ST 0 K1 – ST + P1 – P2
ST ≥ K2 K1 – ST -(K2 – ST) K1 – K2 + P1 – P2

 

In the model of Bear Spread with Call Options, there will be a loss resulting from initial cash outlay if underlying asset prices comes in above K2 after expiry of options. There will be profit if price of underlying ends below K1. This profit comes entirely from wrting call option after deducting cost of buy call option.

Three types of Bear Spreads with Call Options can be distinguished

  1. Both call options are initially out of the money
  2. One call option is initially in the money; the other call option is initially out of money
  3. Both call options are initially in the money

The highest risk and reward Bear Spread with Call Options comes from type 1. They cost very little to set up because they are out of the money but have small probability of giving high payoffs K2 – K1 + P1 – P2 (where P1 << P2 and P1: P2 => 0)

Bear Spread with Call Options

Profit from Bear Spread with call options

(compute based on: volatility 54%, risk free rate on options 10%, K $50, K1 $50, K2 $55, period 6 months, present value of initial cashflow neglected, equity)

 Best Options Trading for Dummies profits on Bear Spread with Call Options using Options Trading 101.