As an option trader, vertical spreads are most likely an integral part of your arsenal as a swing trader. What makes them so worthy of your consideration is the wide variety of risk/reward scenarios depending on one’s outlook. Let’s do a quick comparison of two verticals with bearish outlooks.
One of the nice things about a credit spread is it can profit if the underlying doesn’t move much or if it moves in the intended direction. A debit spread, such as a bear put spread, often needs the underlying to fall to profit.
A bear call spread involves selling a call option while purchasing a higher strike call option with the same expiration. A bear put spread involves buying a put option and selling a lower strike put with the same expiration. The bear call is a credit spread and is usually set up with calls that are out-of-the-money (OTM) in hopes that premium will decrease. The bear put is a debit spread and is generally set up close to at-the-money (ATM) or in-the-money (ITM) in hopes that premium will increase.
An OTM bear call has a higher risk and lower reward. This is because the trade generally has three out of four ways to profit. The underlying can move lower, trade sideways or even move higher and it can still profit. The only way the trade can lose is if the underlying moves too much higher and through the short strike or higher.
A bear put that is ATM or ITM has a higher reward and lower risk than a bear call. The reason is it is more of a directional trade. The underlying generally needs to move lower for the trade to profit. This is why the risk/reward profile is better for the bear put.
When choosing whether to do a bear call or a bear put, a trader also has to consider his or her trading personality. Just because one spread may seem advantageous over another doesn’t mean it should necessarily be implemented. Some option traders cannot bear the thought of taking a maximum loss on a credit spread like the bear call and have trouble sleeping at night worrying about it. But if that is not a major concern for you as a trader, remember that depending on how it is implemented, a bear call spread may offer a lower profit potential but it also provides more of a chance to profit.
Senior Options Instructor
Market Taker Mentoring, Inc.