Most traders can profit from a falling market.
But what if you could not only profit from the stock falling, but also from it going sidewards, or even rising slightly?
The Bear Call Spread, if applied properly, will do all three of these things.
So what is a Bear Call Spread?
The Bear Call spread, as the name describes, is a bearish trade. If applied properly, it can also profit from sidewards movement, or even a slight rise in the market; making it an extremely versatile strategy.
So when would we use one?
Quite often when a stock is channelling, it trades between a strong resistance level, and support level. A bounce from a resistance level is a great indication the stock is likely to continue the pattern, and provides a strong entry signal for a Bear Call spread.
When a stock is in downtrend, you can often draw a downtrend line that represents a strong level of resistance. Once the stock has come back to the trend line, and bounces from the line, it is an indication that the stock is ready to continue the down trend and therefore continue lower. This is also a strong entry signal for a Bear Call Spread.
Why would I use a Bear Call Spread?
We often apply this strategy in a way where we can place all of our risk above a strong resistance level. The resistance level then acts like a last line of defence to stop the stock from rising and going against us. If that level breaks, we often use it as a signal to exit the trade.
The other reason traders like this strategy is it can be managed from afar. It doesn’t require too much attention, and is suitable for traders who perhaps work full time and don’t have the capacity to be actively trading day in day out.
Finally, if applied properly, the trade has an opportunity to close out for zero brokerage and fees, halving the cost of the trade.
Let’s run through an example.
The chart below is of Incitec Pivot Ltd (IPL).
You can see its basically been channelling, perhaps even in a slight downtrend since about the beginning of the year. Recently it rallied to the resistance level and stalled. Today shows it breaking the short-term uptrend line, and therefore a pennant triangle pattern. This gives IPL bearish entry signals.
Now we could trade a bought put, to profit from a quick snap down. On the other hand, we could also consider a Bear Call, which will profit from a move down, but also time decay. IPL can track along the resistance for a period of time before continuing the pattern and heading lower, so a Bear Call may be better suited. This is because simply being in the trade helps us profit, whilst maintaining the ability to profit from a fall.
We can place the risk above the resistance level and downtrend line, which will help protect the trade. As long as the share price stays below these levels we can make maximum profit by expiry.
The ability to have flexibility and wait for the move could provide and edge to your trading, whilst also limiting your capital risk compared to simply shorting the stock.