Volatility Paradox

Overview

A Bear Call Spread (or Call Credit Spread) is the bearish mirror of the Bull Put Spread. It is used when you think a stock has a "ceiling" and is unlikely to rise above a specific price.

Because you are selling a call that is closer to the current price and buying one that is further away, you receive a net credit when opening the trade.

[!TIP] This is a Short Volatility and Negative Delta strategy. You are betting against a rally.

The Setup

A Bear Call Spread consists of:

Short Call: Sell a call at a lower strike ( $K_L$ ). This generates the premium.
Long Call: Buy a call at a higher strike ( $K_H$ ). This provides the "disaster insurance."

Mechanics: Fighting the Rally

Income Generation: You keep the premium if the stock ends below your short strike.
Defined Risk: No matter how high the stock goes, your loss is capped by the long call. This is much safer than selling a "naked" call.
Theta Advantage: Like all credit spreads, time decay is on your side. You want the options to expire worthless.

Payoff and Break-even

Max Profit

The total credit you collected.

\text{Max Profit} = \text{Net Credit Received}

Max Loss

The width of the strikes minus the credit.

\text{Max Loss} = (K_H - K_L) - \text{Net Credit}

Break-even Point

The short strike plus the credit received.

\text{Break-even} = K_L + \text{Net Credit}

The "Ceiling" Greeks

1. Delta: Bearish Bias

You have negative Delta. You make money when the stock price drops. As the stock falls further below your strikes, your Delta approaches zero as you've already reached max profit.

2. Theta: Time is Money

You have positive Theta. If the stock stays flat, you win. This is why many traders prefer credit spreads over buying puts—you don't need a massive crash to make money; a boring market works just fine.

3. Vega: Short Volatility

An increase in market fear (IV) is bad for this trade initially, as it makes the call you sold more expensive. You want the market to stay calm or for IV to drop.

When to Use?

Resistance Levels: You see the stock hitting a "wall" in technical analysis.
Overextended Rallies: You think the market has gone up "too far, too fast" and is due for a pullback or consolidation.
Earnings/Events: You expect a "nothing burger" event where volatility will drop after news is released.

Checklist for Entry

Is my Short Strike above a clear technical resistance level?
Is there a reason for volatility to drop (e.g., post-earnings)?
Am I prepared for the stock to gap up overnight?

Assignment RiskRead more

When you sell a call (the short leg of your spread), you are at risk of assignment. This means someone could force you to sell them 100 shares of the stock at your strike price.

If this happens, your long call is your protection. You can either exercise it to get the shares you need to deliver, or simply close the whole position. Assignment usually only happens if the stock is deep in-the-money or just before a dividend.

Bear Call Spread