The
Bear Call Credit is a strategy for stocks with a bearish
trend.
Important
notice
The
information on this web site is provided solely for general education
and information purposes and therefore should not be considered
complete, precise, or current. Trading
in stocks and options involves risk. You can lose money. You should
always seek professional advice from your stock broker. We are
not stockbrokers and do not make recommendations to buy or sell
any stock or option. We provide educational information for your
evaluation.
Bear Call Credit is a strategy used on a stock that we expect
to go down in price. It can be an effective strategy in a bearish
or down market.The Bear Call Credit involves two different transactions.
First we write or sell a call option that is in-the-money. Since
we are obligated to sell the stock at the strike price, the individual
who buys this call option hopes the stock will increase in price.
If the stock goes down as we expect, the option expires worthless
and we have no further obligation in the deal.
The second step is to purchase a call option out-of-the-money
on the same stock with the same month expiration date. By purchasing
the call option, we are able to limit our losses should the stock
experience a significant price increase. The purchase functions
as a form of insurance on the transaction.
Example; XYZ stock is trading at $78.00:
We would write (Sell) an April in-the-money Call option with
a 75.00 strike price for $5.00 per option.
We would buy an out-of-the money, April call option with a
$80.00 strike price for $2.00 each. This functions as insurance
protecting us if the stock should unexpectedly go over $80.00.
We received $5.00 for writing this option. The purchase of
the call option cost us $2.00. This leaves us with a net credit
of $3.00.
Let's take a look at how this would play out under three different
sceneries:
1. If at expiration date, XYZ Stock trades below 75.00 our profit
would be $3.00 per option.
2. If at expiration date, XYZ Stock trades at $80.00 or higher
our commitment is to provide the stock to the call buyer at 75.00.
Since the stock is currently valued at $80.00, we would be down
$5.00 per stock. However, since we netted $3.00 on the initial
option transactions, our loss is only $2.00 per share. Note: that if
the stock goes higher than $80.00, the additional loss would be
offset by the profit we would make on the call option we purchased.
3. If XYZ stock is trading between the
75.00 and 80.00, then we would figure our cost of XYZ stock
minus our credit of 3.00. If the stock reached $77.00 we would
be out $2.00 after being obligated to sell the stock for $75.00.
However, after factoring in our net credit of $3.00, we are $1.00
ahead on the total transaction.
Write Naked Calls on stocks Out of the
Money. (Note: in the money options tend to be exercised even if
the underlying stock has lost some value but remains over the strike
price.)
