What Is a Bear Spread?

What Is a Bear Spread?

Let me explain what a bear spread is. It's an options strategy you use when you're mildly bearish on a stock or asset, aiming to maximize your profit while keeping losses in check. The idea is to make money if the price of the underlying security drops. You do this by buying and selling either puts or calls at the same time, for the same underlying contract, with the same expiration date but different strike prices.

You can contrast a bear spread with a bull spread, which investors use when they expect moderate increases in the underlying security's price.

Key Takeaways

Here's what you need to know right away. A bear spread is a bearish options strategy for when you expect a moderate decline in the underlying asset's price. You can set up two types: a bear put spread or a bear call spread. In both, you simultaneously buy and sell puts or calls with the same expiration but different strikes. The strategy hits maximum profit if the asset closes at or below the lower strike price.

Understanding Bear Spreads

If you're considering a bear spread, your main reason is expecting a decline in the underlying security—but not a huge one—and you want to profit from it or protect your position. There are two main types you can initiate: a bear put spread and a bear call spread. Both are vertical spreads.

For a bear put spread, you buy one put to profit from the expected decline and sell another put with the same expiry but a lower strike price to offset the cost. This creates a net debit in your account.

On the flip side, a bear call spread means you sell a call to generate income and buy a call with the same expiry but a higher strike to cap upside risk. This results in a net credit.

You can also use ratios in bear spreads, like buying one put and selling two or more at a lower strike. Since it's a spread that pays off on declines, you'll lose if the market rises, but your loss is capped at the premium you paid for the spread.

Bear Put Spread Example

Let's walk through an example. Suppose you're bearish on stock XYZ trading at $50 per share, and you think it'll decrease over the next month. You set up a bear put spread by buying a $48 put and selling a $44 put for a net debit of $1.

The best outcome is if the stock closes at or below $44. The worst is if it closes at or above $48, where options expire worthless and you lose the $1 spread cost. Breakeven is at $47 ($48 strike minus $1 cost). Maximum profit is $3 ($4 difference minus $1 cost), and maximum loss is just the $1.

Bear Call Spread Example

You could also use a bear call spread in the same scenario with XYZ at $50. You sell a $44 call and buy a $48 call for a net credit of $3.

If the stock closes at or below $44, options expire worthless, and you keep the $3 credit. If it closes at or above $48, you lose based on the spread credit minus the $4 difference, netting a $1 loss. Breakeven is $47 ($44 strike plus $3 credit). Maximum profit is the $3 credit, and maximum loss is $1.

Benefits and Drawbacks of Bear Spreads

Bear spreads aren't ideal for every situation. They perform best when the underlying asset falls moderately without big jumps. While they limit your potential losses, they also cap your gains.