
In our previous articles, we covered the Bull Call Spread: Trading Example and Bull Put Spread: Payoff Function & Example. Continuing further in our series of explaination on Options Spread Trading, in this article we detail the Bear Call Spread
Example & Payoff Function of Bear Call Spread
As the name suggests, the Bear Call Spread will be profitable to the buyer of this position when the underlying stock is bearish i.e. the underlying stock price goes down. Secondly, this Bear Call Spread will be prepared using a combination of Call Options and both the profit and loss on this Bear Call Spread trading will be limited to the extent of the spread, hence the name Bear Call Spread.How to construct a Bear Call Spread
A Bear Call Spread can be constructed by combination of 2 options positions. Since the name includes "Call", therefore only call options are required to form a Bear Call Spread as follows:
1) Buy or Long one OTM call option
2) Sell or Short one ITM call option
(To understand what is an ITM or OTM option, See Moneyness of Options  OTM, ATM, ITM Options to know about ATM, ITM and OTM options)
So, when you take the above two positions, what is the net payoff structure you get? Have a look at this Payoff function for Bear Call Spread constituents:
Let's start talking about some numbers here to explain the Payoff function and trading strategy of Bear Call Spread as follows.
Suppose that the underlying stock (say Microsoft) is trading at $30 per share. So let's take the OTM call option to be at $33 and ITM call option to be at $27. Suppose that $27 ITM call option gives you $5 from its sale and $33 OTM option requires you $2 for buying it. Hence, to get into this position, you have to spend a net amount of $5  $2 = $3 (inflow  net received).
For a moment, lets forget about the $2 and $5 prices and concentrate on the combination of the two call option positions which we are getting into.
The GREEN graph shows the SHORT ITM call option with $27 strike price, while the PINK OTM call option with $33 strike price shows the LONG OTM call.
If we add the two, we get the BLUE colored net position (but this is without the price of options taken into consideration). How to add the GREEN and PINK graphs, here it is:
 Below $27, both the GREEN and PINK graphs are ZERO. Hence adding them in the range $0 to $27 gives you ZERO
 Between $27 and $33, the GREEN graph is going down while the PINK graph is ZERO. Hence we get net Green graph
 Above $33, the GREEN graph continues going down and PINK graph goes UP. So the two slnats  up & down  cancel each other and you get a net Horizontal line above $33
The above net payoff function is shown by BLUE graph. Continue to next part Trade Bear Call Spread: Option Strategy Explained
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