Josip Causic

Bear Call Spreads Gone Bad

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This article originally appeared on The Options Insider Web site.

In this article, I will go over three possible outcomes for a bear call spread at expiry. Those scenarios involve the price of the underlying closing within the spread, above the sold call, and below the sold call.

A student of mine e-mailed me pleading with me to explain to him a trade in which the student has gotten into without knowing much about spread trading.

From the e-mail, it could be inferred that the student has taken a bigger position from what is normal. Without disclosing anything about the student, I will go over the facts of the trade.

I have included the chart here, as I usually do for my real trades, but I choose to white out the exact ticker. Thus, when referencing the underlying, I will use that worn out cliché of XYZ.

The daily chart of XYZ below shows (with a blue oval) the point of the initial entry. I have also marked on the chart in green letters the words, "Long Entry." It is at this point that the student went long.

In hindsight, we could observe that from the technical analysis view point, the XYZ at the time of the entry was coming to a resistance, yet that was the exact place where the student went long.

See full-sized chart.

Breaking Down the Trade

I was told in the e-mail that the initial trade on XYZ involved going long on a March 14 call, while XYZ was hitting resistance, as I pointed out above. At that time, the premium for the calls was high, but as soon as XYZ started to head south (way south), the call premium got cheaper.

The next point, marked on the chart with a dark blue oval and the word "Spread," is where the student added more contracts to the existing position, and then turned it into a spread trade.