Bear Spread
Candlefocus EditorIn a bear put spread, the investor buys a lower strike price put option and simultaneously sells a higher strike price put option of the exact same underlying asset and expiration date. The investor hopes the underlying asset will close at or below the strike price of the lower put option. If that happens, the investor gains the most amount of money on the trade. However, if the underlying asset closes above the strike of the higher put option, the investor's maximum gain is limited to the net credit taken in at the start of the trade.
In a bear call spread, the investor buys a lower strike call and simultaneously sells a higher strike call of same underlying asset and expiration date. The investor expects the underlying asset to close at or below the strike price of the lower call option. If that happens, the investor gains the most amount of money on the trade. On the other hand, if the underlying asset closes above the strike of the higher call option, the investor's maximum gain is limited to the net credit taken in at the start of the trade.
A bear spread is a great way to limit downside risk. If the underlying asset declines in price as expected, the investor can achieve a larger return, while limiting the maximum loss to the amount he/she paid to enter the strategy. The gain or loss with a bear spread will depend on the difference between the higher and lower strike prices, as well as the movement of the underlying.
The most important concept to remember with a bear spread is that the more the underlying asset is expected to decline, the larger the spread needs to be. The reason for this is that a large move in the underlying asset can eat into the gains of the bear spread, thereby limiting the profits that can be achieved. The bear spread can be advantageous when used in volatile markets, where the underlying asset may sharply decline, to help mitigate losses while allowing the potential to profit.