A bear call spread is an options strategy used to express a negative or bearish view on the underlying asset, often a broad equity index. By using a spread instead of a naked option, both the profit and loss are limited, and the cost (or premium) for implementing the strategy is limited.
The investor sells a call with strike price X1, earning a premium for doing so. As the stock price rises above X1, the position will start to lose money as the option becomes ‘in the money’ (that is, ‘in’ the money for the buyer of the option). If this were a naked short call, then potential losses could be unlimited if the stock price keeps rising. However, using a spread limits these losses, by buying a call with a strike price X2. As the price rises above X2, the long and short calls offset each other and there is no impact on the profit of the strategy. The reason an investor would use such a strategy instead of buying a put is so that a net premium is received rather than paid. The investor might also have low conviction that the stock price will fall and might instead believe that it’ll stay fairly stable. Finally, an investor could combine a bear call spread with a long position in the underlying stock or equity index, thus earning premium which helps to cushion losses in the underlying stock or equity index.
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