Bearish Outlook? Try These 2 Bear Call Spread Trades on Thursday

A bear call spread is a type of vertical spread, meaning that two options within the same expiry month are being traded.

One call option is being sold, which generates a credit for the trader. Another call option is bought to provide protection against an adverse move.

The sold call is always closer to the stock price than the bought call.

As the name suggests, this trade does best when the stock declines after the trade is open.

However, there can be many cases where this trade can make a profit if the stock stays flat and even if it rises slightly.

Bear call spreads are risk defined trades. There are no naked options here, so they can be traded in retirement accounts such as an IRA.

Traders should have a bearish outlook on the stock and ideally look to enter when the stock has a high implied volatility rank.

Two stocks came up on my screens today as possible bear call spread candidates.

Two Bear Call Spread Candidates

Oracle (ORCL) is sitting below the 21, 50 and 200-day moving averages and the Barchart Technical Opinion rating is a 100% Sell with a Strengthening short term outlook on maintaining the current direction.

Long term indicators fully support a continuation of the trend.

Looking at the chart there are plenty of areas of potential resistance around 170.

Oracle Corporation is one of the largest enterprise-grade database, middleware and application software providers.

Oracle has expanded its cloud computing operations over the last couple of years.

The company offers cloud solutions and services that can be used to build and manage various cloud deployment models.

Built upon open industry standards such as SQL, Java and HTML5, Oracle Cloud provides access to application services, platform services and infrastructure services for a subscription.

Through its Oracle Enterprise Manager offering, the company manages cloud environments.

Oracle's software and hardware products and services include Oracle Database, Oracle Fusion Middleware, Java and Oracle Engineered Systems.

Oracle Engineered Systems include Exadata Database Machine, Exalogic Elastic Cloud, Exalytics In-Memory Machine, SPARC SuperCluster, Virtual Compute Alliance, Oracle Database Appliance, Oracle Big Data Appliance and ZFS Storage.

Implied volatility is high at around 50.06% giving Oracle an IV Percentile of 54%.

Let’s look at how a bear call spread trade might be set up on ORCL stock.

As a reminder, A bear call spread is a defined risk option strategy that profits if the stock closes below the short strike at expiry.

To execute a bear call spread an investor would sell an out-of-the-money call and then buy a further out-of-the-money call. You can find ideas like this using the bear call spread screener.

This particular idea involves selling the March expiry $170 strike call and buying the $175 strike call.

Selling this spread results in a credit of around $0.36 or $36 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:

5 – 0.36 x 100 = $464.

If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 7.76%.

The spread will achieve the maximum profit if ORCL closes below $170 on May 15, in which case the entire spread would expire worthless allowing the premium seller to keep the $36 option premium.

The maximum loss will occur if ORCL closes above $175 on May 15, which would see the premium seller lose $464 on the trade.

The breakeven point for the bear call spread is $170.36 which is calculated as $170 plus the $0.36 option premium per contract.

Let’s look at another idea, this time on Arm Holdings (ARM) which was another stock that came up on my bearish scans.

This bear call spread trade also involves using the May expiration on MSFT and selling the 410-415 call spread.

Selling this spread results in a credit of around $0.70 or $70 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:

5 – 0.70 x 100 = $430.

If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 16.28%.

The spread will achieve the maximum profit if MSFT closes below $410 on May 15, in which case the entire spread would expire worthless allowing the premium seller to keep the $70 option premium.

The maximum loss will occur if MSFT closes above $415 on May 15, which would see the premium seller lose $430 on the trade.

The breakeven point for the bear call spread is $410.70 which is calculated as $410 plus the $0.70 option premium per contract.

Mitigating Risk

With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.

For the ORCL bear call spread, I would set a stop loss if the stock traded above $165.

For the MSFT trade, I would close for a loss if the stock broke through $405.

Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com