What is a bear spread (short definition)
– A bear spread is an options strategy designed to profit when the underlying asset falls modestly in price. It combines two option positions on the same underlying with the same expiration date but different strike prices. The spread limits both potential profit and potential loss compared with a single long or short option.
Key terms (defined)
– Option: a contract giving the right, but not the obligation, to buy (call) or sell (put) an asset at a specified price before expiration.
– Strike price: the price at which the option holder can buy or sell the underlying.
– Net debit / net credit: the cash paid (debit) or received (credit) when opening the spread.
– Vertical spread: a spread that uses two options of the same type (both calls or both puts) with the same expiry and different strikes.
– Ratio spread: a variation that uses unequal numbers of long and short options (e.g., buy one put, sell two puts).
Two common bear spreads
1) Bear put spread (net debit)
– Structure: buy a put at a higher strike and sell a put at a lower strike (same expiry).
– Market view: moderately bearish—expect price to fall but not collapse.
– Cash flow: you pay to enter the position (net debit) because the long put costs more than the short put you sell.
– Payoff characteristics:
– Maximum profit = strike difference − net debit.
– Maximum loss = net debit (if price stays at or above the higher strike).
– Breakeven at expiration = higher strike − net debit.
2) Bear call spread (net credit)
– Structure: sell a call at a lower strike and buy a call at a higher strike (same expiry).
– Market view: mildly bearish or neutral—expect price to stay below the short strike.
– Cash flow: you receive a net credit when initiating the trade.
– Payoff characteristics:
– Maximum profit = net credit (if price is at or below the short strike at expiration).
– Maximum loss = strike difference − net credit.
– Breakeven at expiration = lower strike + net credit.
– Note: because you have a short call, there is assignment risk before expiration if the short option goes in the money.
Worked numeric examples (step-by-step)
Example A — Bear put spread
– Underlying: XYZ trading at $50.
– Trade: buy 48‑strike put, sell 44‑strike put; net cost = $1 (net debit).
– Strike difference = 48 − 44 = $4.
– Maximum profit = $4 − $1 = $3 per share (i.e., $300 per standard 100‑share contract) — occurs if XYZ ≤ $44 at expiration.
– Maximum loss = net debit = $1 per share ($100 per contract) — occurs if XYZ ≥ $48 at expiration.
– Breakeven = 48 − 1 = $47: at expiration the position breaks even if XYZ = $47.
Example B — Bear call spread
– Underlying: XYZ at $50.
– Trade: sell 44‑strike call, buy 48‑strike call; net receive = $3 (net credit).
– Strike difference = 48 − 44 = $4.
– Maximum profit = net credit = $3 per share ($300 per contract) — if XYZ ≤ $44 at expiration.
– Maximum loss = $4 − $3 = $1 per share ($100 per contract) — if XYZ ≥ $48 at expiration.
– Breakeven = 44 + 3 = $47 at expiration.
When to use a bear spread — short checklist
– Market view: you expect a modest decline or a flat-to-down price path, not a steep crash.
– Timeframe: choose an expiration consistent with when you expect the move.
– Volatility: evaluate implied volatility—a bear put costs more when IV is high; bear calls can benefit from higher IV if you receive a larger premium but also carry assignment risk.
– Select strikes: set the strike gap to balance acceptable risk vs. reward.
– Calculate outcomes: compute max profit, max loss, and breakeven before trading.
– Consider assignment and early exercise risk for short options, especially close to expiration.
– Size position to risk only capital you can afford to lose and plan an exit or adjustment path.
Benefits and drawbacks (summary)
– Benefits: limits downside risk compared with a naked short option; reduces net cost compared with a single long put (put spread); can generate income with defined maximum loss (call spread).
– Drawbacks: gains are capped; strategy can still lose money if market rises; short-leg assignment risk exists for call spreads; returns are limited in strong declines relative to a single naked long put.
Practical notes and assumptions
– All dollar amounts above are on a per‑share basis; standard option contracts typically represent 100 shares.
– Examples assume European-style payoff at expiration; American options permit early exercise which can affect results.
– Transaction costs and margin requirements are not included in the simple examples and will affect realized returns.
Further reading (reputable sources)
– Investopedia — Bear Spread: https://www.investopedia.com/terms/b/bearspread.asp
– CBOE (Chicago Board Options Exchange) — Vertical Spreads: https://www.cboe.com/learncenter/default.aspx
– U.S. Securities and Exchange Commission (SEC) — Options Basics: https://www.sec.gov/files/options-investor-bulletin.pdf
– Options Clearing Corporation (OCC) — Options Education:
– Options Clearing Corporation (OCC) — Options Education: https://www.theocc.com/learn
– Options Industry Council (OIC) — Options Education: https://www.optionseducation.org/
Educational disclaimer: This explanation is for educational purposes only and does not constitute individualized investment advice, a recommendation to buy or sell securities, or a prediction of future market performance. Options involve risk and are not suitable for all investors; consider your objectives, risk tolerance, and consult a licensed financial professional before trading.