A bear call spread is a type of vertical spread, meaning that two options within the same expiry month are being traded.
One call option is being sold, which generates a credit for the trader. Another call option is bought to provide protection against an adverse move.
The sold call is always closer to the stock price than the bought call.
As the name suggests, this trade does best when the stock declines after the trade is open.
However, there can be many cases where this trade can make a profit if the stock stays flat and even if it rises slightly.
Bear call spreads are risk defined trades. There are no naked options here, so they can be traded in retirement accounts such as an IRA.
Traders should have a bearish outlook on the stock and ideally look to enter when the stock has a high implied volatility rank.
To stocks came up on my screens today as possible bear call spread candidates.
3M Company (MMM) has drop nearly 38% year-to-date and is rated a 100% Sell with a strongest short term outlook on maintaining the current direction.
Looking at the chart there are plenty of areas of potential resistance between 120 and 130.
3M Company together with its subsidiaries operates as a diversified technology firm. It has manufacturing operations across the globe and serves diversified customer base primarily in the United States, Europe, Middle East and Africa; Latin America/Canada; and the Asia Pacific regions. The company has four business segments. The Safety & Industrial segment mainly serves customers in the electrical, safety and industrial markets across the globe. The Transportation & Electronics segment primarily serves original equipment manufacturers in the electronics and transportation industries across the globe. The Health Care segment engages in serving customers in the global healthcare industry. Businesses within the segment are oral care, medical solutions, food safety, separation and purification sciences, and health information systems businesses. The Consumer segment provides office supply, stationery, home improvement products, homecare products and consumer healthcare products.
MMM is currently below declining 21 and 50-day moving averages and could be a good candidate for a bearish option trade.
Implied volatility is high at around 40%. The twelve-month low for implied volatility is 16.90% and the twelve month high is 44.63%. The IV Percentile is 98%.
That means it could be a great time to be a seller of options on MMM. That coupled with the potential bearish action makes it a candidate for a bear call spread.
MMM Bear Call Spread: November 125 – 130 Bear Call Spread
As a reminder, A bear call spread is a defined risk option strategy that profits if the stock closes below the short strike at expiry.
To execute a bear call spread an investor would sell an out-of-the-money call and then buy a further out-of-the-money call.
This bear call spread trade was found using the bear call spread screener and involves selling the November expiry 125 strike call and buying the 130 strike call.
Selling this spread results in a credit of around $0.45 or $45 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
5 – 0.45 x 100 = $455.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 9.89%.
The spread will achieve the maximum profit if MMM closes below 125 on November 18, in which case the entire spread would expire worthless allowing the premium seller to keep the $45 option premium.
The maximum loss will occur if MMM closes above 130 on November 18, which would see the premium seller lose $455 on the trade.
The breakeven point for the bear call Spread is 125.45 which is calculated as 125 plus the $0.45 option premium per contract.
Let’s look at another idea, this time on McDonald’s (MCD) which was another stock that came up on my bearish scans.
MCD Bear Call Spread: November 250 – 260 Bear Call Spread
This bear call spread trade involves using the November expiration on MCD and selling the 250-260 call spread.
Selling this spread results in a credit of around $1.80 or $180 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
10 – 1.80 x 100 = $820.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 21.95%.
The spread will achieve the maximum profit if MCD closes below 250 on November 18, in which case the entire spread would expire worthless allowing the premium seller to keep the $180 option premium.
The maximum loss will occur if MCD closes above 260 on November 18, which would see the premium seller lose $820 on the trade.
The breakeven point for the Bear call Spread is 251.80 which is calculated as 250 plus the $1.80 option premium per contract.
Mitigating Risk
With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.
For the MMM bear call spread, I would set a stop loss if the stock traded above 117.50.
For the MCD trade, I would close for a loss if the stock broke through 242.50.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
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