Bear Spread Strategy
Secondly, let us understand a ‘Bear Spread Strategy.’
The Bear Spread is quite easy to implement, similar to the bull spread strategy. This can also be devised both with Calls and Puts.
One would implement a Bear spread when the market outlook is moderately bearish, i.e. you expect the market to go down in the near term while at the same time you don’t expect it to go down much.
A spread strategy as we know limits both profits and losses as it involves buying and selling of options of the same category but different strike prices.
Bear Spread using Puts
A risk averse trader would implement Bear Put Spread strategy by simultaneously –
- Buying an In the money Put option
- Selling an Out of the Money Put option
There is no compulsion that the Bear Put Spread has to be created with an IN-THE-MONEY (ITM) and OUT OF-THE-MONEY (OTM) option. The Bear Put spread can be created employing any two put options. The choice of strike depends on the aggressiveness of the trade. However, an important thing to be kept in mind while devising the strategy is - Both the options should belong to the same expiry and same underlying.
A bear put spread is established for a net debit (or net amount of premium paid) and this strategy will profit when the underlying volatility of the stock increases and the stock price also decreases.
A trader is bearish on NIFTY. He sells a Put of Strike Price 17350, receiving a premium of 95 and buys a put of strike 17450 by paying a premium of 147.
Nifty spot price is currently trading at 17360
Maximum Loss: Net Premium Outflow 52
Maximum Profit: Spread- Max Loss 48
Breakeven Point: Higher Strike- Max Loss 17398
As can be seen from the example above the loss and profit are both limited. Maximum loss from this strategy is 52 and maximum profit is 48. The trader would start incurring losses if the price of the underlying asset increases i.e. inverse to what he has been speculating. The volatility of the underlying stock should increase for the strategy to generate profits.
Bear Spread using Calls
As we know spread strategy involves buying and selling options of the same category but different strike prices. Bear call spread involves:
Selling a call at a lower strike price i.e. an In the Money option / At the Money option and Buying a call at a higher strike price i.e. Out of the Money Options.
A bear call spread is established for a net credit (or net amount of premium received) and profits from a declining stock price or passage of time.
Sell a Call of Strike Price 17350, receiving a premium of 111 and buy a call of strike 17450 by paying a premium of 64.
Maximum Loss: Spread- Max profit 53
Maximum Profit: Net Premium Inflow 47
Breakeven Point: Higher Strike- Max Loss 17397
As can be seen from the example above the loss and profit are both limited. Maximum loss from this strategy is 53 and maximum profit is 47. The trader would start incurring losses if the price of the underlying asset increases i.e. inverse to what he has been speculating.
We can say that the bear spread is a great alternative to simply buy a put out right. It can be initiated by either calls or puts. The Underlying Volatility should increase. Calls will have a net premium credit whereas using puts will result in a net premium debit, keeping in mind when the trader is neutral to bearish on the price action in the underlying stock.