Positives In Hard Times

A bear spread with calls can be initiated when you expect the price of A stock to decline moderately 

F&O Glossary

• In-the-money option In a call option, when the strike price of the contract is less than the prevailing spot market price of the underlying stock/index, it's an in-the-money option. It's the opposite in a put option.
• At-the-money options When an option contract is struck at a strike price which is equal to the prevailing market price of the underlying stock/index, it is referred to as an at-the-money option.
• Out-of-money options For call options, when the strike price of the contract is higher than the prevailing spot market price, it is a case of an out-of-money option. For put options, the opposite is true.

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If you have a negative outlook for a stock, a bear spread with calls could be a useful strategy. It’s a limited risk, limited return strategy to be initiated when you expect the stock price to decline by a certain extent. Under this strategy, you buy and sell call options simultaneously—buy the call option at a higher strike price (usually-at-the-money) and sell a call option at a lower strike price.

Returns

You would incur a premium to buy the call option and earn a higher premium when you sell the lower strike price call option. This difference in premiums is the maximum return that could be earned from this strategy. You would earn such maximum return when, at expiry, the spot market price settles below the lower strike call (which has been sold). In this case, both the options will expire without being exercised and you would pocket the entire premium amount. Thus:

Maximum Profit = Net premium received
Maximum profit is attained when spot market price < or = lower strike call

Limited loss if price rises

If the spot market price settles above the higher strike call on the expiry date, the spread will yield you a loss restricted to the difference in the strike price between the two options, minus the net margin amount received when entering the position. In no case can there be a loss in excess of this, irrespective of how high the spot market price goes above the higher strike price.

Maximum loss = strike price of call bought-strike price of call sold-net premium received
Maximum loss occurs when spot market price > = strike price of call bought

When To Use Bear Call Spread

You should use a bear call spread when you expect a downward correction in the price of the underlying stock by a moderate extent. If you have strong conviction of the price declining substantially, you could take a more aggressive position, such as buying a naked put option, but it would involve higher risk if price rises against your anticipation instead of falling.

Advantages

If the stock price rises against your anticipation, even then the loss will be limited. The spread involves lower risk than simply buying a put option to support a bearish stand on the stock price.

Disadvantages

It limits your potential gains in the eventuality of a sharp decline in the price of the underlying stock.