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What are Bullish and Bearish Spreads in Stock Options Strategies?
A Bullish Spread or Bull Spread is a strategy in which the traders of options profit from the increase of the price of the underlying asset of the option. This strategy may contain both put and call options with different strike prices. In a bull call spread, an option is bought at a lower strike price while an option with the same expiry is sold at a higher price.
In a Bull Strategy,
Maximum gain = High strike price − lower strike price − net premium paid
When the price of the underlying goes above the higher strike price, the trader will exercise the call option while the put option will go worthless, and when the lower strike price is above the lower price of the underlying asset, the put option will be exercised (the call option will go worthless). The maximum profit is equal to the difference in the strike prices minus the net premium paid in this case.
The maximum loss, in this case, is the total premium spent for both the calls and the breakeven occurs when the price of the underlying rises above the strike price of the long call option.
A bear spread can be of two types −
- Bear Call Spread
- Bear Put Spread
Bear Call Spread
The Bear Call Spread strategy includes buying a long-term Call Option while simultaneously selling a short-term Call Option of lower strike price having the same expiry date and underlying asset. It requires a premium acquired for selling a Call Option and pay a premium for buying a Call Option. It reduces the cost of investment significantly.
The reward in this moderately risky strategy is limited to the difference in premium received and paid. If the trader thinks that the price of the underlying asset will go down moderately, then this strategy is applied. This strategy is also called the bear call credit spread as a net credit is obtained in the trade. There are limited risks and rewards in the strategy.
Bear Put Spread
In a Bear Put strategy, a Put Option is sold while a Put option is simultaneously bought. In comparison to the Bear Call Spread, one needs to pay a higher premium and receive a lower premium in this strategy. In other words, there is a net debit in premium in this strategy.
The risk in this strategy is limited at the difference in premiums and the profit is limited to the difference in the strike prices of Put Option minus the net premiums. If there is an anticipation of the underlying asset going down moderately, the bear put strategy is used. This strategy is also called the "bear put debit spread". The risk and rewards are limited in this strategy too.
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