Bear Credit Spread Explained

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Calculating Credit Spread from Debt Formula


New Member

In the Stulz reading, Formula 1 should be used to solve Credit Spread (CS):

Formula 1:
CS = -[1/(T) x ln(D/F)] – rf

This formula is actually taken from forumla 2:

Formula 2:
D = F x exp-(rf + cs)T.

However, in the earlier chapter, I learnt that to calculate current Debt, I should use formula 3:

Formula 3:
D = (F x exp-rT) – Put

Why is put value not considered in Formula 1 when solving CS?
Apologies if you have to repeat this again. tried searching for similar question but I was returned with a number of posts.

David Harper CFA FRM

David Harper CFA FRM

It is a interesting direct connection that I have not seen made before (!). If you are interested, in order to verifying the reconciliation, I entered into modified Merton model (see rows 57-65, at the bottom) @

This uses the same De Servigny example of a Merton model. Specifically,
Face value of Debt (F) = $13,
Time (T) = 1.0 years,
Riskfree rate = 4.0%

And then, per Merton type approach:
Price of risky debt (D) = price of risk free debt – put option = $12.49 – 0.35 = $12.14

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And using that price we can solve for an implied spread (Stulz, not really a Merton approach)
= LN(13/12.14) – 4.0% = 2.86% credit spread (s)

It’s a long way to show that these two approaches are not in conflict; they are just different approaches. The first uses asset volatility and option pricing (and therefore no real view on future expectation), the second (by discounting a risky return) does incorporate an expectation. I might summarize the difference as the first is based on volatility, the second based on on discounting (and therefore future expectation).

Discounted price = Merton-based (OPM) price:
F*exp[-(r+s)T] = F*exp(-rT) – p, where p = put option value, such that
F*exp(-rT)*(-sT) = F*exp(-rT) – p, and
F*exp(-rT)*exp(-sT) = F*exp(-rT) * [ 1 – p/F*exp(-rT)], and
exp(-sT) = [ 1 – p/F*exp(-rT)]

… I maybe didn’t find the most elegant relationship, but notice this last equation equates the spread with the put value (and the XLS verifies). Hope that helps rather than confuses, like I said, it’s really interesting to me b/c nobody has drawn the connection before!

Bull Credit Spread

In options trading, a bull credit spread refers to any credit spread in which the value of the spread position decreases as the price of the underlying security rises. The simplest way to construct a bull credit spread is via puts. See bull put spread.

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How to sell Credit Spreads
for Safe, Steady Profits

Selling CREDIT SPREADS is how you can trade options with minimum risk where the deck is definitely stacked in your favour. With this strategy, TIME DECAY works in your favour, and margin requirements are low enough to make it possible for smaller investors. Even if the trade works against you by a certain extent, you still win. Using this strategy, I regularly make at least 15% per month on my portfolio, and have sometimes made up to 70% in one month on an individual stock that is trending strongly. These are not bad gains, especially for beginners, smaller investors and the risk averse.

What is a Credit Spread?

When you sell a credit spread, you simultaneously sell one option and buy one option for a stock as a single transaction. The options are traded for the same expiration month, with different strike prices and are either both call options or both put options. You sell the more expensive option, and buy the cheaper option, resulting in a credit to your account.

Here is an example:

Bear Call Credit Spread

Using trend analysis, you have determined that Stock XYZ is trending down (Bearish). It is quite a strong trend, so you feel secure in placing a trade. XYZ is trading at $100 per share, towards the end of May.

Sell XYZ 120 June Call for 0.80. Credit $80
Buy XYZ 125 June Call for 0.30. Debit (cost) $30 (further OTM, therefore cheaper)
Net Credit $50

You sell an OTM Call Option for XYZ for the closest expiration date (not more than one month out), at a strike price of $120. You simultaneously buy (this is done as one transaction) an OTM call option at a further out strike price (say, $125). You immediately collect the money for this sale. Say the first options costs $0.80, and the second costs $0.30, the difference is $0.50. Because options are always traded in lots of 100, you pocket $50. All you need to do is wait for the option to expire a month later, and you get to keep the money!

Bull Put Credit Spread

Using trend analysis, you have determined that Stock XYZ is trending up (Bullish). It is quite a strong trend, so you feel secure in placing a trade. XYZ is trading at $100 per share, towards the end of May.

Sell XYZ 80 June Put for 0.80. Credit $80
Buy XYZ 75 June Put for 0.30. Debit $30 (further OTM, therefore cheaper)
Net Credit $50

You sell an OTM Put Option for XYZ for the closest expiration date (not more than one month out), at a strike price of $80. You simultaneously buy an OTM Put option at a further out strike price say, $75.

Why buy the further out option? Why not just sell options?

It is simple. If your trade goes against you, and you have sold an option without protection (i.e. a naked option), you have a heavy obligation. You will be obliged to either sell the stock at the strike price (if you sold a call), which means you first need to buy the stock at a higher price (if you are ITM) and then sell it at a lower price. Or you will be obliged to buy the stock at the strike price (if you sold a put), even if the price of the stock is much lower than that price. This means you must have the money available to do that, and your broker requires a pretty high margin to cover your risk. You therefore buy an option at the closest next strike price as a cover or hedge against your trade going wrong.

Even before you get into the trade, you are protected! You have an upfront credit, and you have a very clear idea of how much you can potentially lose. In addition, as you will see, you can manage this trade so that you NEVER lose!

Here is a page with some real live trade examples

TOP TIP: Want to learn more? Here is an options trading video course that takes you step by step through real trades on the TOS trading platform. This course is excellent value for money.

Stock Options Trading and Mentoring – Options strategies from pit vet Dan Passarelli

Posted on Thursday, February 20, 2020 at 1:51 PM

This market is enough to make some option traders crazy and broke. Who would have thought new highs would be consistently made almost on a week-to-week basis? For the most part, the major indexes have moved higher over the past several months, but there have been times when the market inexplicably has done a reversal at some resistance levels, as it did last Thursday. There is an option strategy that can possibly help. Let’s take a look below.

An iron condor is a market-neutral strategy that combines two credit spreads. A call credit spread is implemented above the current stock price, and a put credit spread is implemented below. The objective of any credit spread is to profit from the short options’ time decay while protecting the position with further out-of-the-money long options.

The iron condor is simply combining both the call and put credit spreads as one trade. The trade is based on the possibility of the stock trading between both credit spreads by expiration. Let’s use ABC stock as an example. If you have noticed that the stock has been trading between a range of $75 and $80 over the past few weeks, an iron condor might be an option with an expiration from about a week to about a month.

A call credit spread with the short strike call at 80 or higher would profit if the stock stayed below $80 at expiration. A short strike put at 75 or lower would profit if the stock stayed at $75 or higher at expiration. Both short options would need to be protected by further out-of-the-money (OTM) long options. Both spreads would expire worthless and both premiums are the trader’s to keep if ABC closes at or between the short strikes. The total risk on the trade is also reduced because of both premiums received.

Max profit is both credits from each credit spread. Max risk is the difference in one set of strike prices minus both premiums received. Maximum loss would occur if the stock is at or below $75 or at or above $80 at expiration. No matter what happens, one of the credit spreads will always expire worthless. This, of course, does not guarantee a profit though.

Iron condors are a great way to take advantage of time decay when it looks as if the stock will be traveling in a range for a certain amount of time even in a market like we have seen. The key is to have your profit and loss parameters set before entering the trade.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

Bear Call Spread Explained (Simple Guide)

If you think a stock is going down in the near future and you’d like to make some money without shorting it, consider using a bear call spread strategy.

A bear call spread (or short call spread) is often better than shorting a stock because you don’t need nearly the margin requirement. That’s for two reasons:

  1. Options are much cheaper than stocks
  2. With a bear call strategy, you’re hedged with the purchase of a call option that will offset your short losses

The trick with options, of course, is that they have an expiration date. So the stock will need to drop in value before the contract expires.

A bear call option also offers limited risk and limited return. Even with that limited return, though, you can make bank when the stock moves down.

In this guide, I’ll go over the bear spread so you can determine if you’d like to use it the next time that you’re bearish on a stock.

What Is a Bear Call Spread ?

A bear call spread is a type of vertical spread.

If you’re unfamiliar with a vertical spread, it’s an options strategy that involves buying and selling the same kind of options at different strike prices but with the same expiration date.

Let’s say American Express is currently trading at $108 per share. If you buy the $109 call for $2.20 and sell the $106 call for $3.90 and both calls have the same expiration date, then you’ve just created a vertical spread.

In the case of a bear call spread, you get a credit. That means you’ll get some cash in your account up front because the sale of the call at a lower strike price earns you more money than the cost of the call at the higher strike price.

In the example above, you’d get a credit of $170 ($390 – $220).

When Would You Use a Bear Call Spread ?

Use a bear call spread when you think a stock is going moderately down in value in the near term.

There are a few points to keep in mind:

  • The stock really needs to go down for you to make money. If the stock goes up in value, you’ll lose money.
  • The stock needs to go down in value during the short term. If it goes down after the expiration date, that doesn’t do you any good. So you need a time target as well as a price target.
  • The stock should drop in price only moderately. That’s because your gains are limited. If it drops significantly, you’ll still make money, but you could have made more money by just buying a put option.

How Does a Bear Call Spread Work?

First things first: make sure your trading platform allows you to place multi-leg options orders. That way, you can sell one option position while simultaneously buying the other one.

Start by purchasing an out-of-the-money call option for a specific stock and expiration date. Then, sell an in-the-money call option for that same stock and expiration date.

Because the in-the-money call option has a higher on the open market than the out-of-the-money call option, you’ll get cash for the transaction right away.

That net credit, by the way, is your maximum profit. A bear call spread is an options strategy that gives you the maximum potential profit right away.

Keep in mind: you should also buy and sell the same number of options contracts. In other words, if you buy three options contracts, you should sell three options contracts.

If the underlying stock does indeed go down in value, both of the options expire worthless. That’s not a problem, though, because you’ve already earned your profit.

Real Life Example Using a Bear Call Spread ?

Let’s say that Walmart is currently trading at $101 per share. You think it’s going to dip slightly in the near future, so you’d like to open a bear call spread position.

You buy the $103 call option for $2.55. That will cost you $255 because options contracts consist of 100 shares ($2.55 x 100 = $255).

Next, you sell the $100 call option for $4.44. That puts a credit in your account of $444 ($4.44 x 100).

The net credit to your account from the multi-leg order is $189 ($444 – $255). That’s your maximum profit for the trade.

If Walmart drops down to $99.50 at expiration, then both of your options expire worthless. In that case, you keep your net credit.

On the other hand, if Walmart shoots up to $105, you’re in trouble. In that case, you sell the $103 call option for $400 ($4 x 100) and buy back the short position for $700 ($7 x 100).

That means you’d be out $300 ($700 – $400). Relative to the amount of money you invested, that’s a steep loss.

Here are a few strategies similar to a bear call spread:

  • Bull Call Spread – Works just like a bear call spread except that you’re bullish on the stock. A key difference, though, is that it doesn’t give you a net credit right away.
  • Bear Put Spread – Involves buying an in-the-money put option while simultaneously selling an out-of-the-money put option for the same stock at the same expiration date. As its name implies, it’s a strategy you’d use when you think the stock is going down in value over the short term.
  • Collar Strategy – Involves selling calls against a stock that you own while simultaneously buying protective puts. It’s a limited-risk, limited-return strategy.

Bear Call Spread Compared to Other Options Strategies?

A bear call spread is one of several options strategies that offer limited risk and limited return.

Although you can make a healthy return with a bear call spread, you can’t “let your winner run” as you would with a stock or option you purchased outright. That’s because the short position will limit your profit.

Even with that limit, though, you still can make a very nice return with a bear call spread. Even better: you can earn that return in as little as 1-2 months.

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