Bear Spread

Accumulation/Distribution Indicator - A/D Definition and Uses

What is a Bear Spread?

A bearish spread is an option strategy implemented by a slightly bearish investor wishing to maximize his profits while minimizing losses. The objective is to provide the investor with a profit when the price of the underlying security drops. The strategy is to buy and sell put or call options for the same underlying contract simultaneously with the same expiration date but at different strike prices.

Understanding the spread of the bear

The main motivation for an investor to execute a bearish spread is that he expects the underlying security to fall, but not appreciably, and that he wishes to profit from it or protect his existing position. The opposite of a bearish spread is a bullish spread, which is used by investors who expect a moderate rise in the underlying security. There are two types of bearish spreads that a trader can initiate – the bearish spread put and the bearish spread call. Both are classified as vertical spreads.

A bearish sell spread involves buying a put, in order to take advantage of the expected fall in the underlying security, and selling (writing) a put with the same maturity but at a lower strike price for generate income to offset the purchase cost of the put. . This strategy results in a net debit on the trader’s account.

A bearish spread call involves selling (writing) a call, to generate income, and buying a call with the same maturity but at a higher strike price to limit the upside risk. This strategy results in a net credit on the merchant’s account.

Bearish spreads can also involve ratios, such as buying a put to sell two or more put at an exercise price lower than the first. Because it is a spread strategy that pays off when the underlying falls, it will lose if the market rises – however, the loss will be capped at the premium paid for the spread.

Key points to remember

  • A bearish spread is an option strategy implemented by a slightly bearish investor wishing to maximize his profits while minimizing losses.
  • There are two types of bearish spreads that a trader can initiate – the bearish spread put and the bearish spread call.
  • The strategy is to buy and sell put or call options for the same underlying contract simultaneously with the same expiration date but at different strike prices.

Bear Spread Example

The investor is bearish on XYZ stock when it is trading at $ 50 per share and thinks that the share price will drop over the next month. The investor buys a put of $ 48 and sells (writes) a put of $ 44 for a net debit of $ 1. The best scenario is that the stock price ends at $ 44 or less. In the worst case, the stock price ends at $ 48 or more, the options expire worthless and the trader lowers the cost of the spread.

Breakeven point = 48 strike – propagation cost = $ 48 – $ 1 = $ 47

Maximum profit = ($ 48 – $ 44) – propagation cost = $ 4 – $ 1 = $ 3

Maximum loss = propagation cost = $ 1

Bear call propagation example

The investor is bearish on XYZ stock when it is trading at $ 50 per share and thinks that the share price will drop over the next month. The investor sells (writes) a call for $ 44 and buys a call for $ 48 for a net credit of $ 3. Ideally, if the stock price ends at $ 44 or less, the options expire worthless and the trader retains the credit spread. The worst case is that if the stock price ends at $ 48 or more, the trader lowers the amount of the credit spread less ($ 44 – $ 48).

Breakeven point = 44 strike + spread credit = $ 44 + $ 3 = $ 47

Maximum profit = spread credit = $ 3

Maximum loss = spread credit – ($ 48 – $ 44) = $ 3 – $ 4 = $ 1

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