Market Weakness Is Growing: Time to Look at Bear Call Spreads?

With the market coming into a seasonally weak time of year, Bear Call Spreads could be an interesting trade to consider.

A bear call spread is a type of vertical spread, meaning that two options within the same expiry month are being traded.

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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.

Let’s take a look at Barchart’s Bear Call Spread Screener for September 16th:

As you can see, the screener shows some interesting Bear Call Spread trades on stocks such as TSLA, AVGO, BA, GLW and UBER.

Below are the full parameters for this scan:

Opinion Rating: Sell greater than 1% Days to expiration: 15 to 60 days Monthly Expirations Security Type: Stock Volume Leg 1: 100 Open Interest Leg 1: 500 Moneyness Leg 1: -10.00% to 0.00% Volume Leg 2: 100 Open Interest Leg 2: 500 Ask Price Leg 2: Greater than 0.20

Let’s look at the first line item – a Bear Call Spread on Tesla stock.

Using the October 16 expiry, the trade would involve selling the $360 call and buying the $365 call. 

That spread could be sold for around $2.00 which means the trader would receive $200 per contract into their account. The maximum risk is $300 for a total profit potential of 66.67% with a loss probability of just 45.0%.

The breakeven price is $362. This can be calculated by taking the short call strike and adding the premium received.

As the spread is $5 wide, the maximum risk in the trade is 5.00 – 2.00 x 100 = $300.

The Barchart Technical Opinion rating is a 56% Sell with a Average short term outlook on maintaining the current direction.

Long term indicators fully support a continuation of the trend.

Let’s analyze another trade – a Bear Call Spread on Broadcom.

This Bear Call Spread on Broadcom stock involves selling the $340-strike October call and buying the $350-strike call.

That spread could be sold for around $395, which means the trader would receive $395 into their account. The maximum risk is $605 for a total profit potential of 65.29% with a loss probability of 44.7%.

The breakeven price is $343.95.

The Barchart Technical Opinion rating is a 56% Sell with a Strengthening short term outlook on maintaining the current direction.

Mitigating Risk

Thankfully, Bear Call Spreads are risk defined trades, so they have some build in risk management. The most the Tesla example can lose is $300 and the maximum loss on the Broadcom trade is $605.

Position sizing is important so that a 100% loss does not cause more than a 1-2% loss in total portfolio value.

Bear Call Spreads can also contain early assignment risk, so be mindful of that if the stock breaks through the short strike and it’s getting close to expiry.

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 had a position in: TSLA . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.

 

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