US stock markets tumbled today primarily driven concerns over tariffs and cuts to the federal workforce.
One way to use options to profit from declining stock prices is via a bear call spread.
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.
Let’s take a look at Barchart’s Bear Call Spread Screener for March 11th:
As you can see, the screener shows some interesting Bear Call Spread trades on stocks such as META, AMZN, AVGO, MSFT, AAPL and QCOM.
Let’s look at the first line item – a Bear Call Spread on META stock.
Using the April 17 expiry, the trade would involve selling the $600 call and buying the $610 call.
That spread could be sold for around $4.65 which means the trader would receive $465 into their account. The maximum risk is $535 for a total profit potential of 86.92% with a profit probability of 53.1%.
The breakeven price is $604.65. This can be calculated by taking the short call strike and adding the premium received.
As the spread is $10 wide, the maximum risk in the trade is 10 – 4.65 x 100 = $535.
The Barchart Technical Opinion rating is a 40% Buy with a Weakest short term outlook on maintaining the current direction.
Let’s analyze another trade – a Bear Call Spread on Amazon.
The first Bear Call Spread on AMZN stock involves selling the $195-strike April call and buying the $200-strike call.
That spread could be sold for around $2.30 which means the trader would receive $230 into their account. The maximum risk is $270 for a total profit potential of 85.19% with a profit probability of 54.4%.
The breakeven price is $197.30.
The Barchart Technical Opinion rating is a 8% Sell with a Average short term outlook on maintaining the current direction.
The market is approaching oversold territory. Be watchful of a trend reversal.
Mitigating Risk
Thankfully, Bear Call Spreads are risk defined trades, so they have some build in risk management. The most the META example can lose is $465 and the maximum loss on the AMZN trade is $270.
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.
