Bear spread is an options strategy which is made of two Put options. In bear Spread Trader buys a put option and also sells a put option of same expiry but of lower strike.
Traders use a Bear spread when they are mildly bearish on stock in near term but willing to buy for longer term. So bought put gives them option to sell stock at relatively higher price and sold call provides them a hedge. This is a “Limited Profit – Limited risk” options strategy.
Let’s Assume, Share price of ABC Corp is Rs. 54. Trader A is mildly bullish on the stock and expects it to reach up to Rs. 50 but not more than Rs. 46 in few weeks’ time. In this case, he can opt bear spread.
So In above case, Trader can buy put option of 56/58 Strike and sell call option of 44/42 strike (buying and selling of put options are dependent to individual’s risk).
There are three possible scenarios,
In First case, if at the time of expiry underlying share price of ABC Corp. remained between the strikes of bought and sold puts. Then, Option premium of bought put will be higher than buying premium and sold put will expire worthless.
This will be the ideal scenario, because trader will have “positive payoffs” of both bought and sold puts.
In scenario two, if at the time of expiry underlying share price of ABC Corp. expires above the strikes of bought put. Then, Option premium of bought put will be lower than buying premium but sold put will expire worthless and act as hedge.
In above example, payoff of bought put will be negative but since sold put will expire worthless, payoff will be positive and will act as hedge.
In third case, if at the time of expiry underlying share price of ABC Corp. expires below the strikes of bought and sold put. Then, Option premium of bought put will be higher than buying premium but sold put won’t expire worthless.
In this case, payoff of bought put will be positive but negative for sold put but premium of bought call will take care of incurred losses.
While trading via Bear spread – since, its “Limited Profit – Limited risk” strategy trader will not get protection from sudden spurts or declines in share prices.
While trading options full filling margin requirements is necessary. To check what margin is required to trade put options check SAMCO’s SPAN calculator.
Quick Facts for Trading Put Options
Buying Call Options
Margin Applicable – None, however option premium is payable upfront.
Risk – Reward – Maximum Loss is restricted to the premium, whereas the maximum profit can be the strike price in case the price of the underlying asset goes to zero.
Selling Call Options
Margin Applicable – Premium is received by the seller and credited to ledger however margin is payable for holding the short position. Check the Margin requirements for writing options on the SAMCO Margin Calculator.
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