If you're hesitant to commit to the bears’ camp Will long-term resistance keep the shares of RSH in check? Andrea Kramer (akramer@sir-inc.com) The bear call spread (also referred to as a “short call spread”), is an essential tool in the options trader's playbook, allowing traders to make money on a stock’s moderate move into the red, while also capping risk.

Who should tune in? The bear call spread is best suited for investors expecting the underlying shares to stay stagnant or retreat in the short-to-intermediate term. Part of the allure of this strategy is the limited risk, which is relatively mild when compared to straight bearish plays like selling stock short or writing calls. In other words, the short call spread is appealing to moderately skeptical speculators who can’t quite commit to the bears’ camp.

How does it work? To implement this strategy, the investor would sell an at- or out-of-the-money call on a stock with seemingly bearish prospects – or at least potential resistance looming overhead. However, to reduce his risk in the wake of an unexpected rally, the trader would simultaneously buy a cheaper, higher-strike call with the same expiration date.

What’s in it for me? Similar to the short call position, the objective of the bear call spread is for the underlying stock to finish at or below the sold call strike at options expiration. In this scenario, all of the calls will expire worthless, allowing the strategist to pocket the net premium received at initiation – which represents the most the investor can possibly gain on the play. As such, the addition of the long call not only trims the trader’s maximum risk, but also his maximum reward.

What do I have to lose? As with any pessimistic position, the worst-case scenario for the bear call spread is for the underlying equity to unexpectedly skyrocket during the calls’ lifespan. This, however, is where the long call comes in as a virtual insurance policy, capping the trader’s maximum loss at the difference between the call strikes, less the initial net credit.

To avoid incurring a loss on the spread, the strategist needs the underlying equity to remain beneath the breakeven level, which is calculated by adding the net credit to the sold call strike.

(Don’t forget to include any brokerage fees, margin requirements or commission costs.)

In Conclusion

A bear call spread can be a great alternative to writing a lone call or shorting a stock outright, since the purchase of the out-of-the-money call helps trim the overall risk of the position. However, with limited risk comes limited reward. If the underlying stock finishes beneath the sold call strike by options expiration, the strategist will still reap a reward – just not as generous a profit as the trader who committed to the bearish bandwagon.