Recently the following question was posed: “When do we use a Bear Call spread instead of an Iron Condor?” The simple answer would be when the time frame that we are trading is showing a clear downtrend with no obvious support (demand zone) in sight, from which the underlying could bounce back up violently. However, there is so much more to this question than meets the eye, so let us look at one short vertical call spread that would have worked well and compare it against a short Iron Condor that would have gone wrong.
PART I: BEAR CALL with a Max Profit
Let’s assume that the underlying is trading at the time of entry at 81.82 and a vertical call spread is sold. The sold vertical call spread is also known as a Bear Call, for it is built by calls, yet the strategy is not a bullish one. The aggregate of the two options’ deltas (sold call and bought call) produces a negatively correlated delta. Whenever the delta is negative, the position’s outlook is bearish by nature. A short Bear Call benefits from time decay, hence, it is wise to sell a Bear Call when the implied volatility is high or at its higher range.
When placing the actual Bear Call trade, it is essential that the trader determine where the price will not be at expiry. If, for instance, the trend is bearish and an underlying is trading below a major area of resistance, then that resistance could be used for strike price selection. For instance, if an optionable stock is trading at 81.82 and the 95 zone is acting as a significant level of resistance, then selling the front month 95 call would make perfect sense.
However, prior to the sale of the 95 call, the next higher strike price needs to be purchased; otherwise, the trader would end up with a naked 95 call position. Such a position might require a large maintenance by the brokerage house,… Continue Reading
