Bear Spread

A bear spread is an options strategy that combines two options of the same type and expiry at different strikes so that the position gains if the underlying asset falls in price. Both the possible profit and the possible loss are fixed when the trade is opened. It is one of the basic vertical forms of option spread and the opposite of a bull spread.

The strategy is used by traders who hold a moderately bearish view and want defined risk. It can be built in two ways: with puts, paying a premium at the start, or with calls, receiving one. The term is also used in futures markets for a position that is short a near delivery month and long a later one.

• Bear put spread. The trader buys a put option at a higher strike and sells a put at a lower strike. The trade costs money to open, so it is a debit spread. See bear put spread.
• Bear call spread. The trader sells a call option at a lower strike and buys a call at a higher strike. The call sold is worth more than the call bought, so the trader receives a net credit. See bear call spread.

In both versions the option bought has the higher strike and the option sold has the lower strike. In the call version the purchased call caps the loss that the sold call could otherwise cause. In the put version the sold put caps the gain and lowers the cost.

Let $K_L$ be the lower strike price, $K_H$ the higher strike, and $W = K_H - K_L$ the width between them. For the put version, with net premium paid $D$:

For the call version, with net premium received $C$:

In each case the maximum profit is reached when the underlying finishes at or below the lower strike, and the maximum loss when it finishes at or above the higher strike.

A share trades at $100 and a trader expects it to weaken over the next two months.

Put version: buy the $100 put for $4.00 and sell the $90 put for $1.50. The debit is $2.50. The maximum profit is 10 − 2.50 = $7.50, the maximum loss is $2.50, and the break-even is 100 − 2.50 = $97.50.

Call version: sell the $100 call for $3.00 and buy the $110 call for $0.80. The credit is $2.20. The maximum profit is $2.20, the maximum loss is 10 − 2.20 = $7.80, and the break-even is 100 + 2.20 = $102.20.

The two trades differ in what they need from the market. The put spread loses its full cost if the share stays at $100 and needs a fall below $97.50 to profit. The call spread keeps its full credit if the share stays at or below $100 and loses only if the share rises above $102.20.

The debit version has a smaller, known outlay and a larger possible gain relative to that outlay, but a lower chance of profit. The credit version has a higher chance of a small gain and a larger possible loss. A broker will require margin for the credit spread, normally equal to its maximum loss.

Time decay also separates them. The passing of time, measured by theta, generally helps the credit spread and hurts the debit spread when the price is near the upper strike. Pricing matters too: when implied volatility is high, options are expensive, which favors selling the credit spread; when it is low, the debit spread is cheaper to buy. With European-style options and matching strikes, put-call parity ties the two versions together, so neither is systematically better before costs.

A bear spread loses if the price rises or, for the debit version, merely fails to fall. The loss is capped, but it can be the whole amount at stake. Compared with short selling the asset, the spread avoids unlimited loss and the need to borrow shares, at the cost of a capped gain and a fixed time limit.

With American-style options, the short leg may be assigned before expiry, most often when it is deep in the money or, for calls, just before a dividend. If the price ends between the strikes at option expiry, only one leg is exercised and the trader is left with a share position. Many traders close spreads before the last day for that reason. Trading two options doubles the commissions and bid-ask costs.

In commodity futures, a bear spread means selling a nearby futures contract and buying a more distant one in the same commodity. It gains if the near month weakens relative to the far month, which tends to happen when supply is ample. This is a calendar spread and has no built-in limit on loss in the way the options version does.