Option Basics-The Bear Call Credit Spread

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I love stock options. They offer a variety of ways to make money, control risk, greatly increase the ROI (Return on Investment) and conserve capital. One strategy that could be very applicable in these volatile times is the Bear Call Credit Spread.

The title describes the strategy: The trader thinks that the price of the underlying has a high probability of remaining in a tight range or will decrease in value. Thus, the terminology “Bear”.

A call is when the trader purchases the rights to buy a certain number of the underlying shares for the specified option period if the stock is at or above the agreed to strike price. When a call is purchased by the trader it is called a long call. When the call option is purchased, the purchase price is debited to the trader’s account. However, the same trader can sell a call option. This is called a short call. When a call is sold, the trader receives a premium payment from the buyer for each share. The total premiums for selling (also called writing a call) are credited to the trader’s account. Thus, the terminology “Credit”.

But there is a risk when selling calls. If the stock doesn’t act as the trader had hoped and reverses direction, an increase in the underlying stock will also put upward pressure on the derivative call option. If the price of the stock goes well beyond the strike price of the option contract, there is the risk that the buyer of the call will exercise their rights and have the stock assigned. In which case, the call option seller must provide the underlying stock promised in the option contract. The seller of the call will then need to make good on the obligation. To help protect the seller from a big move against the position, the trader will purchase a call option for the same security in the same expiration month but at a higher strike price than the call(s) that was sold. Therefore, if the price zooms up, the call seller will have an opportunity to participate in the contrary move and the gains will help to offset some of the losses from the call that was sold (written). Thus, the terminology “Spread”; spread the risk between the two contracts.

Bear Call Credit Spread summary: the trader makes money by selling any number of calls with the expectation that the option will not go into-the – money before expiration and the trader will be able to keep the premiums gained from the sale. The higher strike price, which makes up the spread, is insurance against a contrary move. Considering that about 80% of stocks don’t move very much, this strategy can be very effective in stagnant or declining markets.

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