Comparing the Bear Call Spread and the Bear Put Spread - Option Ideas

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In previous articles I have discussed the Bear Call Spread and the Bear Put Spread. Both of these strategies have many things in common. They are used when you expect the price of the underlying stock to stay flat or drop slightly.

Either strategy requires the purchase and sale of the same type of option. For the Bear Call Spread, you buy a Call at one strike price (often out of the money) and sell a Call at a lower strike price (often in the money). The Bear Put Spread is similar; you buy a Put at one strike price (usually in the money) and then sell a Put at a lower strike price (usually out of the money). Both Strategies have very defined gain and loss points. You set the maximum loss and maximum gain for the trade through your selection of the strike prices of the options. Of course, the most notable difference between the two is that the Bear Call Spread is a credit spread and will immediately bring money into your account. Whereas, the Bear Put Spread is a debit spread and will cost you money to buy it. So, how do you determine which strategy is the best to use on a stock for which you have a flat to slightly bearish expectation? Let's examine two commonly used techniques for choosing between the two strategies. One approach involves comparing the Implied Volatilities of the two spreads. A second approach is to compare the maximum losses that might be incurred by each spread. Implied Volatility If your trading platform supplies you with the IV (Implied Volatility) percentages, you can use a common rule of thumb to make a quick comparison. It is often assumed that when IV is high there is more profit in selling and when IV is low it is more profitable to buy. Using this approach, you use the Bear Call Spread when IV is high and the Bear Put Spread when the IV is low. So what is 'high' and what is 'low'? Well, it is a good idea to compare the IV to the historical volatility of a specific stock. This helps you to see whether the current IV is higher or lower than normal for that specific stock. Compare Maximum Loss Another comparison method is to calculate the maximum loss of each strategy. I prefer using this approach because I am inclined to first look at the potential loss of a position. This analysis is done by setting up both trades so that each spread has the same strike prices. Then compare the losses that would be incurred if the trade went against you and the stock price moved up instead of down. Look at this set up for both the Bear Call Spread (Credit) and he Bear Put Spread (Debit) on SPY, which was trading at $132.02 at the time of the trade: Example #1 - Strikes at $131/$132: Maximum Profit of the CALL spread is $0.46 [ $1.23 - $0.77 ]
Maximum Profit of the PUT spread is $0.36 [ ($132 - $131) - ($2.05 - $1.41) ] Maximum Loss of the CALL spread is $0.54 [ ($132 - $131) - ($1.23 - $0.77)]
Maximum Loss of the PUT spread is $0.64 [ $2.05 - $1.41] The CALL spread will lose less than the PUT spread: $0.54 vs. $0.64. Example #2 - Strikes at $129/$133: Maximum Profit of the CALL spread is $1.46 [ $1.89 - $0.43 ]
Maximum Profit of the PUT spread is $1.88 [ ($133 - $129) - ($2.80 - $.68) ] Maximum Loss of the CALL spread is $2.54 [ ($133 - $129) - ($1.89 - $0.43)]
Maximum Loss of the PUT spread is $2.12 [ $2.80 - $0.68] The PUT spread will lose less than the CALL spread: $2.12 vs. $2.54. Conclusion Both the Bear Call Spread and the Bear Put Spread have the same objective. This is to profit when the stock price is expected to stay relatively unchanged or to go down, but to not go down a significant amount. These are excellent trades for when a stock is expected to go down, but is likely to not go lower than a strong support level. When evaluating which of the two would be the best trade to place, a common approach is to use the Bear Call Spread when the Implied Volatility is high. Use the Bear Put Strategy when the Implied Volatility is low. A second, perhaps more conservative, approach is to compare the maximum loss of each spread. Using this approach you would trade the CALL or the PUT spread depending on which would generate the smallest lost if the trade went against you and the stock price went up instead of down. You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here. And be sure to check out our Zacks Options Trader . Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
 
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



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