Feeling down about this correction?
Don't worry, there's still a way to profit! In this article, we'll show you two bear call spread trades you can make this Friday.
These strategies are designed to help you navigate the downturn and come out ahead.
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.
Advanced Micro Devices (AMD) is sitting below declining 21, 50 and 200-day moving averages and is showing signs of distribution.
AMD stock is rated a 100% Sell with a Strongest short term outlook on maintaining the current direction.
Looking at the chart there are plenty of areas of potential resistance around 140.
Advanced Micro Devices offers the industry's broadest portfolio of leadership high-performance and adaptive processor technologies, combining CPUs, GPUs, FPGAs, Adaptive SoCs and deep software expertise to enable leadership computing platforms for cloud, edge and end devices.
Implied volatility is high at around 51.84%.
The twelve-month low for implied volatility is 34.25% and the twelve-month high is 64.76%. The IV Percentile is 70%.
Let’s look at how a bear call spread trade might be set up on AMD stock.
AMD Bear Call Spread: Feb $140 – $145 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.
This bear call spread trade was found using the bear call spread screener and involves selling the February expiry $140 strike call and buying the $145 strike call.
Selling this spread results in a credit of around $0.75 or $75 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 – 0.75 x 100 = $425.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 17.6%.
The spread will achieve the maximum profit if AMD closes below $140 on February 21, in which case the entire spread would expire worthless allowing the premium seller to keep the $75 option premium.
The maximum loss will occur if AMD closes above $145 on February 21, which would see the premium seller lose $425 on the trade.
The breakeven point for the bear call Spread is $140.75 which is calculated as $140 plus the $0.75 option premium per contract.
Let’s look at another idea, this time on Marvell Technologies (LLY) which was another stock that came up on my bearish scans.
LLY Bear Call Spread: Feb $880 – $890 Bear Call Spread
This bear call spread trade also involves using the February expiration on LLY and selling the 880-890 call spread.
Selling this spread results in a credit of around $1.90 or $190 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:
10 – 1.90 x 100 = $810.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 23.5%.
The spread will achieve the maximum profit if LLY closes below $880 on February 21, in which case the entire spread would expire worthless allowing the premium seller to keep the $190 option premium.
The maximum loss will occur if LLY closes above $890 on February 21, which would see the premium seller lose $810 on the trade.
The breakeven point for the Bear call Spread is $881.90 which is calculated as $880 plus the $1.90 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 AMD bear call spread, I would set a stop loss if the stock traded above $135.
For the LLY trade, I would close for a loss if the stock broke through $850.
Watch out for earnings dates as well.
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.
