Bear Call Spread

When your feeling on a stock is generally negative, bear spreads are nice low risk, low reward strategies. One of the easiest way to create a bear spread is by using call options at or near the current market price of the stock.

Like bear put spreads, bear call spreads profit when the price of the underlying stock decreases. Bear call spreads are typically created by selling at-the-money calls and buying out-of-the-money calls.

Example

Using the Nasdaq-100 Index Tracking Stock, we can create a bear call spread using in-the-money options. With QQQQ Trading at $30.11 in May, you might buy ten of the JUL 32 calls and sell ten JUL 30 calls.

With the underlying stock trading near $30, you'd sell the 30 calls for $1.85 and buy the 32 calls for $1. This way, you'd initiate the spread for a credit of $850, your maximum profit. If the stock moves lower, both calls will expire worthless and you'll keep the $850 premium you collected when you initiated the position.

QQQQ trading @ $30.11
Buy 10	JUL 32 Calls @ $1.00	$1,000
Sell 10	JUL 30 Calls @ $1.85	($1,850)
Credit from Trade		($850)

If you like the idea behind the bear call spread, be sure to check out bull call spreads and bear put spreads. These can be comparable strategies depending on your objectives.

Put Back Spread

Put back spreads are great strategies when you are expecting big downward moves in already volatile stocks. The trade itself involves selling a put at a higher strike and buying a greater number of puts at a lower strike price.

Ideally, this trade will be initiated for a minimal debit or possibly a small credit. This way, if the stock gains ground, you won't suffer much either way. On the other hand, if the stock drops as you hope, the profit potential will be significant because you have more long than short puts. To maximize the potential for this position, many traders use in-the-money options because they have a higher likelihood of finishing in-the-money.

Example

Using Intel (INTC), we can create a put backspread using in-the-money options. With INTC Trading at $30 in April, you might buy two of the May 30 puts at $1.25 and sell one May 32.5 put at $2.70.

In this example, you would receive $20 for putting on the trade. If the stock jumped above 30, you would profit $20. However, the real money would be made if the stock made a big move to the downside. The downside breakeven for this trade would be 27.50. At this price, the 30 puts would be worth $2.50 while the 32.5 puts would be worth $5. Below $27.50 the profit potential increases dramatically.

INTC trading @ $30.06
Buy 2	May 30 Put @ $1.25	$250
Sell 1	May 32.5 Put @ $2.70	($270)
Credit from Trade		($20)
Option requirements to maintain position		250

The profit/loss above does not factor in commissions, interest, or tax considerations.

Calculating the Breakeven

The easiest way to calculate the downside breakeven is by using the following formula:

Downside Breakeven = Long strike price - [(Long strike - short strike) * # of short contracts] + net credit/100 (or - net debit)

Using the data for this example, the breakeven calculation looks like this:

30 - [(30-32.5) * 1] - 20/100

Simplified, the equation becomes:

30 - [(2.30)] = 27.70

Learn more about pricing options.

Long Puts

Now let's imagine that you have a strong feeling a particular stock is about to move lower.

Before puts came into existence, your only alternative was to short sell the stock. Short selling stock is an incredibly risky strategy. Should the stock move higher, your loss would be theoretically unlimited. Rather than opening yourself to enormous risk, you could buy puts (the right to sell the stock at a fixed price).

Example

Let's look at an example option. Cisco is trading at $16.07. The JUN 15 puts are trading for $0.55. For $55 you could buy one JUN 15 put (100 shares x $0.55). Since each contract controls 100 shares, you now have the right to sell 100 shares at $15 per share. If the stock stays at or above $15.00 before the option expires, the most you could lose is your initial investment of $55.

On the other hand, if the stock falls to $11 at expiration, the JUN 15 put will be worth $4 (strike price: $15 � current stock price: $11). At this point, your put is worth $400 ($4 x 100 shares). After subtracting the cost of the premium paid and before commissions your gain is $345, a 627% gain on your investment.

To achieve the same percentage gain on a typical stock trade, a $100 stock would have to increase in value to nearly $800 per share. Needless to say, that doesn't happen every day.

To better see the leverage of options, let's look again at the returns on a percentage basis.

	Purchase $	Sale $	Profit (L)	%Gain (L)
Stock Price	$15.90	$11.00	$4.90	30.8%
Short 100 Shares	$1,590.00	$1,100.00	$490.00	30.8%
1 Jun 15 Put	$55.00	$490.00	$430.00	716.7%

Now, let's see what happens if the stock unexpectedly rises.

	Purchase $	Sale $	Profit (L)	%Gain (L)
Stock Price	$15.90	$20.00	($4.10)	(25.8%)
Short 100 Shares	$1,590.00	$2,000.00	($410.00)	(25.8%)
1 Jun 15 Put	$55.00	$0.00	($55.00)	(100%)

If you sold the stock short at $15, thinking it would go down, and it rose quickly to $20, you can buy the stock and limit your losses. In this case, you would lose $500 (100 shares x $5 share). It's also easy to see that this could get worse. The stock could continue climbing indefinitely. Had you purchased the puts rather than sold the stock short, your loss would be limited to the price of the puts-in this case $55.

To make a profit, the buyer of these options has to be right about the price movement of the stock and the time frame in which it will occur. If the stock doesn't make its move before the options expire, they will expire worthless. While a stockholder is concerned with market direction, the timeframe isn't as critical because stock doesn't have an expiration date. You can hold a stock for decades. You can't do the same with options. With the exception of LEAPS (long-term option contracts), most options expire in a matter of months.

The Condor

Using the same option and stock prices we used for the , we can examine a similar position known as a condor.

The Long Condor

The condor takes the body of the butterfly � two options at the middle strike � and splits it between two middle strikes rather than just one. In this sense, the condor is basically a butterfly stretched over four strike prices instead of three.

Long 70 call, Short 75 call
Short 80 call, Long 85 call

You can also view a condor as a combination of a bull and bear call spread.

Long 70 call, short 75 call (bull call spread)
Short 80 call, long 85 call (bear call spread)

The long condor can be a great strategy to use when your feeling on a stock is generally neutral because it's been trading in a narrow range. Like the butterfly, the condor is a limited risk, limited reward strategy that profits in stagnant markets.

Imagine that a stock trading at $75 has been relatively flat for some time. If you think the situation is unlikely to change, you can sell one 75 call and one 80 call. At the same time, you'd buy one 70 call and one 85 call as a hedge in case the market moved against you. This combination of options creates the long condor. The position is considered "long" because it requires a net cash outlay to initiate.

Long Condor
Sell	1 75 Call @ $6.00	($600) (condor body)
Sell	1 80 Call@ $4.00	($400) (condor body)
Buy	1 70 Call @ $9.00	$900 (wing)
Buy	1 85 Call @ $2.00	$200 (wing)
Cost of Trade		$100 ($1,100-$1,000)

* Note: the same position can be established using puts.
The profit/loss above does not factor in commissions, interest, or tax considerations.

In this case, the maximum profit is achieved at expiration with the stock between 75 and 80. At $75, the 75, 80, and 85 calls would expire worthless and the 70 calls would be worth $500. Thus, you would achieve your maximum profit of $400 ($500 - $100 initial debit). Between 75 and 80, the loss on the short 75 calls is more than offset by the 70 calls. Since the 80 and 85 calls would again expire worthless, the value at expiration is the same as the value of the 70/75 bull call spread ($5).

At any price above $85 or below $70, you would experience the maximum loss of $100.

If you like the idea behind the condor, be sure to check out long butterflies and short butterflies. These can be comparable strategies depending on your objectives.