IBM had an incredible run in the last few months, but looks like it could use some time to digest those gains. If IBM stock does pause, a bear call spread let's an options trader benefit from the passage of time, especially with a belief that the upside is limited in the short term. Though bearish, this strategy still achieves maximum profit as long as IBM doesn't rise more than 12% from here.
Setting Up A Bear Call Spread On IBM Stock
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy can be profitable if the stock trades lower, sideways, and even if it trades slightly higher, as long as it stays below the short call at expiry.
Using a December expiry bear call spread on IBM with our short call at 250 and the long call at 255. The short call traded around 2.72 this morning and the long call at 2.05. That brings in a net credit of 67 cents. If IBM stock is below 250 at expiration, the whole spread expires worthless and that credit remains yours to keep. Since each contract is 100 shares, that's $67 per contract in your pocket.
What about the loss? If you went with just the short call, you would get a lot more premium to keep but you would also have unlimited loss potential if the stock jumped sharply over 250.
The long call acts as protection. If IBD stock goes above the 255 long-call strike, the gains of the long call start countering the losses of the short call. That means the most you can lose is $433. The calculation for the maximum loss is the distance between the strike prices less the premium received.
That represents a maximum potential return on risk of 15.5% between now and Dec. 20.
Time Is On Your Side
Credit spreads offer another strong benefit besides the defined risk. Time is on your side. Barring big moves in the stock to the upside, the passage of time makes the spread less valuable. Since you received a credit, that means you can close the trade at a lower price and the difference is your profit.
The spread achieves maximum profit if IBM closes below 250 on Dec. 20 which makes the value of the spread go to zero. With IBM trading at around 222 this morning, that means even with a 12% gain, this bearish trade still gets maximum profit.
You Don't Need To Wait For The Maximum Loss
The maximum loss is if IBM closes above 255 on Dec. 20 but you don't need to wait for that to happen.
Using a stop loss if IBM stock trades above 245 could minimize that loss potential substantially. Or if the spread value doubles, from the current 67 cents to 1.34, that could also suggest its time to exit.
As this is a bearish position, traders that think IBM stock is looking at much higher move from here should not enter this trade.
The position starts with a delta of -4, meaning it is roughly equivalent to being short 4 shares of IBM stock.
According to the IBD Stock Checkup, IBM stock is ranked No. 3 in its industry group. It has a Composite Rating of 90, an EPS Rating of 70 and a Relative Strength Rating of 91.
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.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
