Bear Spread

A bear spread is a strategic options trading method used by investors who anticipate a moderate decline in an asset’s price. It involves buying and selling options of the same type with different strike prices but the same expiration date. Designed to limit both risk and profit, bear spreads are popular among traders seeking controlled exposure in bearish markets. This beginner-friendly strategy is ideal for those looking to profit from falling prices without taking on the high risk of outright short selling. 

What Is a Bear Spread? 

A bear spread is a conservative options trading strategy that allows investors to benefit from a moderate decline in the price of an underlying asset. It involves buying and selling options of the same type, either call or put options, with the same expiration date but different strike prices. The aim is to profit from a bearish market view while clearly defining both potential profit and risk. 

Bear spreads fall under the category of “vertical spreads,” where the only difference between the two options is the strike price. Traders choose this strategy when they anticipate a slight or moderate drop in the asset’s value rather than a sharp fall. It is attractive to investors who want to cap their risk and reduce exposure compared to outright short selling or buying a single option contract. 

Understanding Bear Spread 

Bear spreads are used by traders who expect the price of an underlying security, such as a stock or an index, to decline modestly over a given time period. Instead of using more aggressive methods like selling the stock short (which involves unlimited risk), the bear spread limits potential losses and profits, making it a defined-risk strategy. 

The strategy is built on two core principles: 

• Reducing the initial cost of entering a bearish position. 

• Controlling the maximum loss by offsetting the risk through an opposite position. 

For example, buying a put option allows you to profit when prices fall. However, put options can be expensive, especially during times of high volatility. To reduce the cost, a bear spread involves selling another put option at a lower strike price, thereby collecting a premium that partially offsets the cost of the bought put. 

Bear spreads are commonly used by beginner and intermediate traders who seek to capitalise on expected declines in asset prices while maintaining a disciplined risk management approach. 

Types of Bear Spread 

Bear spreads can be executed using two different types of options: 

1. Bear Put Spread

• Involves buying a put option with a higher strike price and selling another put with a lower strike price. 

• Both options have the same expiration date. 

• This is considered a debit spread because you pay a net premium to enter the trade. 

• Maximum profit is realised if the underlying asset falls to or below the lower strike price at expiration. 

• Ideal for traders with a stronger bearish market outlook. 

2. Bear Call Spread

• Involves selling a call option with a lower strike price and buying another call with a higher strike price. 

• Both options have the same expiration date. 

• This is considered a credit spread because you receive a net premium when you open the position. 

• Maximum profit is realised if the underlying asset stays at or below the lower strike price. 

• Best suited for traders with a moderately bearish or neutral market view. 

Comparison Table 

Uses and Strategies of Bear Spread 

Bear spreads offer flexibility and risk control in bearish or range-bound market environments. Traders and investors may employ these strategies in the following scenarios: 

Common Uses: 

• Moderate Bearish Outlook: When expecting a gradual or slight price decline in a security, but not a significant crash. 

• Cost Control: Helps reduce the cost of purchasing options by selling another option simultaneously. 

• Risk Limitation: Clearly defines the maximum loss, which is ideal for risk-averse traders. 

• Hedging Existing Positions: Can be used to hedge long positions in a portfolio without needing to sell off holdings.
   

Strategic Considerations: 

• Strike Price Selection: Choose strike prices that align with the anticipated price movement of the asset. 

• Time Frame: Opt for expiration dates that allow the asset sufficient time to reach the target price range. 

• Volatility Impact: Be aware of how implied volatility affects option premiums, particularly when constructing bear put spreads during periods of high volatility. 

• Market Timing: Enter trades when momentum indicates a reversal from bullish to bearish. 

Examples of Bear Spread 

To better understand how bear spreads function in real market conditions, let’s look at two practical examples- one in the US stock market and the other on the Singapore Exchange (SGX). 

Example 1: Bear Put Spread (US Market) 

Imagine a trader anticipates a modest drop in the price of a well-known US tech stock currently trading at US$100. 

• Buy one put option with a strike price of US$105 for a premium of US$6 

• Sell one put option with a strike price of US$95 for a premium of US$2 

• Net premium paid: US$4 (debit)
   

Scenario Outcomes: 

• If the stock closes at or below US$95:
   

• Both options are in the money. 

• Maximum profit = (US$105 – US$95) – US$4 = US$6
   

• If the stock closes above US$105:
   

• Both options expire worthless. 

• Maximum loss = US$4 (premium paid)
   

• Break Even point = US$105 – US$4 = US$101 

This example illustrates how the trader benefits from a decline in the stock’s price but has a capped downside. 

Example 2: Bear Call Spread (SGX Market) 

Suppose a trader expects an SGX-listed stock, currently trading at SGX 100, to remain neutral or slightly fall shortly. 

• Sell one call option with a strike price of SGX 95 for SGX 7 

• Buy one call option with a strike price of SGX 105 for SGX 2 

• Net premium received: SGX 5 (credit) 

Scenario Outcomes: 

• If the stock closes at or below SGX 95:
   

• Both options expire worthless. 

• Maximum profit = SGX 5 (net premium)
   

• If the stock closes above SGX 105:
   

• Loss = (SGX 105 – SGX 95) – SGX 5 = SGX 5 

• Break Even point = SGX 95 + SGX 5 = SGX 100 

This approach is practical in sideways or gently bearish markets where the trader does not expect significant price swings. 

Frequently Asked Questions