Spread Trading: An Introduction to Trading Options in Nine Simple Steps

CHAPTER 39

The Bear Call

“Now,we talked earlier about a debit strategy in using the call in struments,” said Nate. “In the ‘bull call,’ we paid more for our long call than we took in for our short call and thus started out with a net debit—we started out in the hole.”

“And,” continued Aaron, “in that trade we used the long call as our primary instrument—as the main way to make profit. We did this by placing the long call strike near the money so that it would grow faster in value as the stock grew in value. And we used the short call as the limiting instrument—as the main way to reduce risk in the trade.”

“And notice,” added Nate, “that this short call reduced our risk in two ways. For one thing, by merely selling this call we brought a credit into the trade and thus reduced our cost basis—the total amount of our investment. But in addition, we also placed the short call strike further out of the money than the long call, which meant that it would have a lower delta—and would therefore grow in value more slowly than the long call. This was what allowed the spread between the values of the two options to grow, and thus was the basis for making a profit. And keep in mind that this strategy was designed for a bullish trend; it works only when the stock price is increasing.”

FIGURE 39.1 The Bear Call

“But now we’re going to see how to use these same call instruments in a credit trade,” ...