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.
Two stocks came up on my screens today as possible bear call spread candidates.
Pfizer (PFE) has been in a downtrend for a few months and is rated an 88% Sell with an average short term outlook on maintaining the current direction. Long term indicators fully support a continuation of the trend.
Looking at the chart there are plenty of areas of potential resistance around $38-$40.
Pfizer Inc. is a research-based, global biopharmaceutical company. The company boasts a sustainable pipeline with multiple late-stage programs that can drive growth. Pfizer markets a wide range of drugs and vaccines. Its business comprises six business units - Oncology, Inflammation & Immunology, Rare Disease, Hospital, Vaccines and Internal Medicine.
Pfizer spinned-off its Upjohn unit, its off-patent branded and generic established medicines business, and combined it with generic drugmaker Mylan to create a new generic pharmaceutical company called Viatris.
The Consumer Healthcare (CHC) segment, an over-the-counter (OTC) medicines business, was merged with Glaxo's unit to form a new joint venture.'The Consumer Healthcare joint venture with Glaxo and the merger of Upjohn unit with Mylan has made Pfizer a smaller company with a diversified portfolio of innovative drugs and vaccines.
PFE is currently below declining 50 and 200-day moving averages and could be a good candidate for a bearish option trade.
Implied volatility is moderate at around 21%. The twelve-month low for implied volatility is 18.44% and the twelve month high is 35.97%. The IV Percentile is 22%.
Let’s look at how a bear call spread trade might be set up on PFE stock.
PFE Bear Call Spread: September 510 – 515 Bear Call Spread
As a reminder, A bear call spread is a defined risk option strategy that profits if the stock closes below the short strike at expiry.
To execute a bear call spread an investor would sell an out-of-the-money call and then buy a further out-of-the-money call.
Bearish traders could sell the September expiry 37.50 strike call and buy the 42.50 strike call.
Selling this spread results in a credit of around $0.80 or $80 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
5 – 0.80 x 100 = $420.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 19.05%.
The spread will achieve the maximum profit if PFE closes below 37.50 on September 15, in which case the entire spread would expire worthless allowing the premium seller to keep the $80 option premium.
The maximum loss will occur if PFE closes above 42.50 on September 15, which would see the premium seller lose $420 on the trade.
The breakeven point for the bear call Spread is 38.30 which is calculated as 37.50 plus the $0.80 option premium per contract.
Let’s look at another idea, this time on Moderna (MRNA) which was another stock that came up on my bearish scans.
MRNA Bear Call Spread: September 200 – 205 Bear Call Spread
This bear call spread trade also involves using the September expiration on MRNA and selling the 145-150 call spread.
Selling this spread results in a credit of around $0.55 or $50 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
5 – 0.55 x 100 = $445.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 12.36%.
The spread will achieve the maximum profit if MRNA closes below 145 on September 15, in which case the entire spread would expire worthless allowing the premium seller to keep the $55 option premium.
The maximum loss will occur if MRNA closes above 145 on September 15, which would see the premium seller lose $445 on the trade.
The breakeven point for the Bear call Spread is 145.55 which is calculated as 145 plus the $0.55 option premium per contract.
Mitigating Risk
With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.
For the PFE bear call spread, I would set a stop loss if the stock traded above 37.50.
For the MRNA trade, I would close for a loss if the stock broke through 135.
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 did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
