Bear call spreads and bull put spreads are a nice short premium way to play a directional bias. If a trader thinks that stock is going down, but doesn’t have an strong opinion on where it is going, for example no expected event move or a technical level, then a bear call spread can be a way to receive credit for the spread if stock moves down at all or at least doesn’t go up. If one has a general directional bias across the market this can be a higher probability way to trade a number of stocks rather than picking points for buying out-of-the-money calls or puts. BUT, this is true only for out-of-the-money bear call spreads or bull put spreads. Let’s discuss the bear call spread. An out-of-the-money bear call spread is a short premium position in the sense that the trader wants stock to stay still or move down. At expiration, in either of those cases, the call spread is worth zero so the trader has made whatever money he or she received from selling the spread. Decay is his or her friend. On the other hand, let’s look at an at-the-money bear call spread. Let’s look at the GOOG Dec22 685/690 bear call spread with stock trading $688.80.
A trader could sell this call spread, bid to ask, for $2.50. But, if expiration were today, the spread would be worth $3.80. Therefore we cannot think of this at-the-money bear call spread as a short premium position in the sense we usually do even though we have received money for it. If stock were to do nothing, we’d lose money on the spread. Decay is not our friend. We need stock to move at least $1.30 down to be intrinsically profitable. Our max profit is $2.50 if stock goes down and max loss is $2.50 if stock goes up and the spread goes to $5. If stock stays still we would lose $1.30. So, just a note that when you consider an at-the-money bear call spread or bull put spread, you need to think about it a little differently and look at your risk to reward and conviction level considering the intrinsic value of the spread. Putting a trade on for a credit is not the same as the spread having time on its side.