Bear Spreads Explained

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Bear Put Spread

What Is a Bear Put Spread?

A bear put spread is a type of options strategy where an investor or trader expects a moderate decline in the price of a security or asset. A bear put spread is achieved by purchasing put options while also selling the same number of puts on the same asset with the same expiration date at a lower strike price. The maximum profit using this strategy is equal to the difference between the two strike prices, minus the net cost of the options.

As a reminder, an option is a right without the obligation to sell a specified amount of underlying security at a specified strike price.

A bear put spread is also known as a debit put spread or a long put spread.

Key Takeaways

  • A bear put spread is an options strategy implemented by a bearish investor who wants to maximize profit while minimizing losses.
  • A bear put spread strategy involves the simultaneous purchase and sale of puts for the same underlying asset with the same expiration date but at different strike prices.
  • A bear put spread nets a profit when the price of the underlying security declines.

The Basics of a Bear Put Spread

For example, let’s assume that a stock is trading at $30. An options trader can use a bear put spread by purchasing one put option contract with a strike price of $35 for a cost of $475 ($4.75 x 100 shares/contract) and selling one put option contract with a strike price of $30 for $175 ($1.75 x 100 shares/contract).

In this case, the investor will need to pay a total of $300 to set up this strategy ($475 – $175). If the price of the underlying asset closes below $30 upon expiration, the investor will realize a total profit of $200. This profit is calculated as $500, the difference in the strike prices [$35 – $30 x 100 shares/contract] – $300, the net price of the two contracts [$475 – $175] equals $200.

Advantages and Disadvantages of a Bear Put Spread

The main advantage of a bear put spread is that the net risk of the trade is reduced. Selling the put option with the lower strike price helps offset the cost of purchasing the put option with the higher strike price. Therefore, the net outlay of capital is lower than buying a single put outright. Also, it carries far less risk than shorting the stock or security since the risk is limited to the net cost of the bear put spread. Selling a stock short theoretically has unlimited risk if the stock moves higher.

If the trader believes the underlying stock or security will fall by a limited amount between the trade date and the expiration date then a bear put spread could be an ideal play. However, if the underlying stock or security falls by a greater amount then the trader gives up the ability to claim that additional profit. It is the trade-off between risk and potential reward that is appealing to many traders.

Less risky than simple short-selling

Works well in modestly declining markets

Limits losses to the net amount paid for the options

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Risk of early assignment

Risky if asset climbs dramatically

Limits profits to difference in strike prices

With the example above, the profit from the bear put spread maxes out if the underlying security closes at $30, the lower strike price, at expiration. If it closes below $30 there will not be any additional profit. If it closes between the two strike prices there will be a reduced profit. And if it closes above the higher strike price of $35 there will be a loss of the entire amount spent to buy the spread.

Also, as with any short position, options-holders have no control over when they will be required to fulfill the obligation. There is always the risk of early assignment—that is, having to actually buy or sell the designated number of the asset at the agreed-upon price. Early exercise of options often happens if a merger, takeover, special dividend or other news occurs that affects the option’s underlying stock.

Bear Spreads

A bear spread is an option spread strategy used by the option trader who is expecting the price of the underlying security to fall.

Vertical Bear Spreads

The vertical bear spread is a vertical spread in which options with a lower striking price are sold and options with a higher striking price are purchased. Depending on whether calls or puts are used, the vertical bear spread can be entered with a net credit or a net debit.

Vertical Bear Credit Spread

A vertical bear spread can be established for a net credit if call options are used. The strategy is also known as the bear call spread.

Vertical Bear Debit Spread

A vertical bear spread can be established for a net debit if put options are used. The strategy is also known as the bear put spread.

Horizontal & Diagonal Bear Spreads

The bear calendar spread and the diagonal bear spread are both time spread strategies used by option traders who believe that the price of the underlying security will remain stable in the near term but will eventually fall in the long term.

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Bear Spread

What is a Bear Spread?

A bear spread is an options strategy implemented by an investor who is mildly bearish and wants to maximize profit while minimizing losses. The goal is to net the investor a profit when the price of the underlying security declines. The strategy involves the simultaneous purchase and sale of either puts or calls for the same underlying contract with the same expiration date but at different strike prices.

Understanding Bear Spread

The main impetus for an investor to execute a bear spread is that they expect a decline in the underlying security, but not in an appreciable way, and want to either profit from it or protect their existing position. The opposite of a bear spread is a bull spread, which is utilized by investors expecting moderate increases in the underlying security. There are two types of bear spreads that a trader can initiate – bear put spread and bear call spread. Both are classified as vertical spreads.

A bear put spread involves the buying a put, so as to profit from the expected decline in the underlying security, and selling (writing) a put with the same expiry but at a lower strike price to generate revenue to offset cost of buying the put. This strategy results in a net debit to the trader’s account.

A bear call spread involves selling (writing) a call, to generate income, and buying a call with the same expiry but at a higher strike price to limit the upside risk. This strategy results in a net credit to the trader’s account.

Bear spreads can also involve ratios, such as buying one put to sell two or more puts at a lower strike price than the first. Because it is a spread strategy that pays off when the underlying declines, it will lose if the market rises – however, the loss will be capped at the premium paid for the spread.

Key Takeaways

  • A bear spread is an options strategy implemented by an investor who is mildly bearish and wants to maximize profit while minimizing losses.
  • There are two types of bear spreads that a trader can initiate – bear put spread and bear call spread.
  • The strategy involves the simultaneous purchase and sale of either puts or calls for the same underlying contract with the same expiration date but at different strike prices.

Bear Put Spread Example

Investor is bearish on stock XYZ when it is trading at $50 per share and believes the stock price will decrease over the next month. The investor buys $48 put and sells (writes) a $44 put for net debit of $1. Best case scenario is if the stock price ends up at or below $44. Worst case scenario is if the stock price ends up at or above $48, options expire worthless, and trader is down the cost of the spread.

Break even point = 48 strike – spread cost = $48 – $1 = $47

Maximum Profit = ($48 – $44) – spread cost = $4 – $1 = $3

Maximum Loss = spread cost = $1

Bear Call Spread Example

Investor is bearish on stock XYZ when it is trading at $50 per share and believes the stock price will decrease over the next month. The investor sells (writes) $44 call and buys a $48 call for a net credit of $3. Best case scenario is if the stock price ends up at or below $44 then the options expire worthless and the trader keeps the spread credit. Worst case scenario is if the stock price ends up at or above $48 then the trader is down the spread credit minus ($44 – $48) amount.

Break even point = 44 strike + spread credit = $44 + $3 = $47

Maximum Profit = Spread credit = $3

Maximum Loss = Spread credit – ($48 – $44) = $3 – $4 = $1

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