Terminology Archives | Page 71 of 76

Mar

2022

What Does Bullish and Bearish Mean in Investing and Crypto?

By Paulina Likos | Growing Wealth, invest, Investing, Terminology | Comments Off

Markets are often described as being either bullish vs. bearish. These are common terms used to refer to how a market is performing over a short or longer period of time. Investors can also be bullish or bearish on a specific stock, a sector, an asset class such as cryptocurrency, or on the economy in general.

Read on to learn more about the definitions of bearish vs. bullish, where the terms bullish and bearish come from, and the bullish and bearish meaning for investors in stocks, cryptocurrency, or other markets.

What Does Bullish Mean?

Bullish refers to stock market sentiment that the direction of the overall market will go up. A market that is increasing in value over a long period of time is said to be in a bull market. A bullish trend means that there may be an upward trend in prices for an asset.

For investors, being bullish means they feel positive about a stock, index, or the overall stock market. For example, if an investor says she is bullish on Apple (AAPL) stock, the investor expects the market value of AAPL stock to increase in the long-term. That bullishness may even compel the investor to buy more shares of the company.

A bullish market is one where prices go up by 20% after a sustained 20% decline.

What Does Bearish Mean?

Bearish refers to a sentiment that the direction of securities or the overall market will move down in price. An investor characterized as a bear believes the stock market will decrease in value, even if current prices are going up. An investor investing in a bearish market may even sell shares of their portfolio if they believe the market will turn negative.

A bear market is one that has fallen 20% from recent highs and remains below that threshold for at least two months. Since investors are bearish during this period, there may be lower trading activity.

Where Do the Terms Bullish and Bearish Come From?

While there are several theories as to the origins of bullish vs. bearish. The consensus believes the difference between bullish and bearish reflects the way each animal responds when they attack. When a bull goes into attack mode, it races at its target with confidence. In a bull market, investors are confident that stock prices will rise and correspondingly, the value of the market will trend upward.

When bears attack, they swipe their paws in a downward motion and often in fear. That is why in a bear market, prices drop. When investors are bearish, they do not have confidence in stocks and usually end up selling off some of their investments.

Bullish vs Bearish in Cryptocurrency

The terms bullish and bearish have historically been used in the context of the stock market. But these terms can apply to any market, including the cryptocurrency market. The definitions of bullish and bearish are largely similar in the context of trading crypto.

When cryptocurrencies are rallying, this means crypto is in a bull market. During this period, there is strong demand and, in some cases, limited supply. Bullish crypto traders may talk about prices going “to the moon,” which refers to periods when prices might surge or suddenly spike (these price moves can also happen in times of extreme volatility).

A bearish trend in the crypto market reflects falling prices accompanied by selling. But sometimes, crypto traders may consider a bear market a great time to add to their crypto portfolio. These traders may be hoping to “HODL,” which stands for “hold on for dear life,” and refers to the goal of investors riding out volatility.

Pump-and-Dump in Crypto

Sometimes bullish or bearish movements in cryptocurrency reflect more than market sentiment. A “pump and dump” scheme in the crypto market refers to a group of market participants buying up large amounts of a cheap cryptocurrency to artificially increase its price.

They then relay positive messages about the asset to get other investors to buy in. Once prices soar, they sell off their assets and pocket the profits while others lose value.

How Bullish Markets Can Impact Investors

In a bull market, demand is greater than supply. There are many investors who want to buy stocks while only a few are willing to sell. Bullish traders tend to have long positions in stocks or other assets.

How Bearish Markets Can Impact Investors

In a bear market, supply is greater than demand — and investors look to offload their shares when there is not a lot of demand for market participants to buy. As a result, share prices decrease. A bear market is challenging for investors because stock prices keep falling, and that means more losses in an investment portfolio.

Your first instinct may be to sell in a bear market, but to increase chances of securing a profit in the long-term, it may make more sense to remain invested. Bear markets do not last forever.

Still, some investors prefer to adjust their investments in a bear market, turning to defensive stocks like consumer staples, healthcare, or utilities. They also may consider going into safer investments like bonds that offer stable fixed-income.

Bear markets can also present a good buying opportunity for investors who use dollar-cost averaging. This involves investing a fixed amount of money consistently. This way, investors can purchase stocks at a more affordable price. Learn more about

Tips on Withstanding Bullish vs Bearish Markets

One of the best investing strategies during a bull or bear market is diversification. Diversifying your investment portfolio with different securities in a variety of different industries — along with various asset classes — will protect a portfolio by minimizing losses and maximizing gains over the long-term. Diversification means buying shares of companies in different sectors and companies of different sizes, rather than just investing in a select few of stocks.

Stock Market

Investors who are not sure how to pick individual stocks can purchase an exchange-traded fund (ETF) or index fund, which are pre-selected baskets of securities all in one investment vehicle. For example, investors who own a fund that follows the S&P 500 will see their investments perform in line with that index.

In an ETF, investors own hundreds of companies, which means they don’t need to painstakingly choose one or two companies, rather, they own the entire index. This is a great strategy to ensure portfolio growth in the long-term.

Cryptocurrency

Because cryptocurrency is a relatively new asset class that has only been around for about 12 years, it can be difficult to know when a bull or bear period is approaching and how long it may last. One of the main characteristics of cryptocurrencies is their volatility. Assets with more volatility are riskier for investors. A crypto bear market or bull market can last for a period of hours, days, weeks, or months.

Crypto investors can also diversify by purchasing different types of cryptocurrencies, and keeping their overall crypto assets to a certain percentage of their wider portfolio.

The Takeaway

A market doesn’t necessarily have to be either bearish or bullish. It can actually be neither. The stock market can be in a state that is flat. This may mean there are normal market fluctuations leading to either small gains or small losses. Even if markets experience a sharp decline or rise in the short-term, this still cannot be defined as bearish or bullish because bull and bear markets are maintained over a period of time.

Whether you believe we’re in a bullish or a bearish market, a good way to get started investing is by opening an online brokerage account on the SoFi Invest® investment platform. With SoFi Invest, users can easily buy and sell stocks and exchange-traded funds directly from their phone.

FAQ

Does being bearish mean that you want to sell your crypto or other assets?

A bearish market period means investors think an asset’s price is headed downward. In some cases, people are not even aware of a bear market until it’s over because it’s difficult to predict the direction of the markets. Investors who are invested for the long run do not pay attention to the peaks and troughs of the market and take a dollar-cost averaging approach by investing consistently over time in both bear and bull markets.

What do bullish and bearish mean in crypto?

A bullish market in crypto means the value of the cryptocurrency will increase, while a bearish market means the asset will go in the opposite direction. Bearish investors are pessimistic that the market will decline — but there is so much momentum in the crypto market that when there is a bearish period, it is often seen as a buying opportunity to get more crypto.

How can you tell if a market is bearish or bullish?

Predicting and timing the markets is a challenging task. However, if stock prices have fallen by more than 20% from their recent peaks, and remained there for more than two months, that’s typically considered a bear market. A sustained increase in prices is a bull market.

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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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Mar

2022

What Is a Derivative?

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

A derivative is a financial instrument that derives its value from an underlying asset, such as a stock or bond, or a benchmark, such as a market index. Derivatives can also represent statistics or numerical indexes not related to financial assets.

Derivative investments work as a contract between two parties, a buyer and seller. The derivative is a secondary security, meaning it is not an asset itself, but rather it tracks the value of an underlying asset. This puts it into the category of secondary securities. The value of a derivative is based on market events, price changes, and other factors related to the underlying asset.

Experienced investors often use derivative finance to hedge their investments against future loss or profit from upcoming market shifts, but some investors also use them to profit or speculate on commodities like gold or oil. They can serve different purposes for different people, such as limiting risk related to possible future events.

How Does a Derivative in Finance Work?

A derivative is a contract that includes information about rules and asset costs for a particular future transaction that may take place. For instance, if an investor has a significant amount of a particular stock with an unrealized gain, they might choose to enter into a derivative contract that gives them the ability to sell it at today’s prices on a future date. This will give them some protection against future losses.

Derivatives are also a way to give investors exposure to a certain asset class without having to actually buy the assets. The seller of a derivative doesn’t have to actually own the underlying asset. They can give the buyer money to buy the asset, or they can give the buyer another derivative contract of the same value of the first one.

Derivative Example

You might have a derivative that provides you with the right to purchase 50 shares of a particular stock for a set price of $1,000 per share in six month’s time. This will be a valuable contract if the stock is trading higher than $1,000 and continues to trade at that level in six months. But if the stock goes down in value and trades under $1,000 per share then the derivative won’t have any value.

3 Types of Derivatives

There are two categories of derivatives: lock and option. Lock contracts include swaps and futures. These form an obligation between the two parties. Option contracts give the parties the right, but not the obligation, to fulfill the contract transaction.

Options

One of the most common examples of a derivative is an options trade, which gives traders the right to buy or sell a stock at a specific price within a certain period of time. The options buyer will pay a “premium” is paid upfront, but when the contract expires the right to buy or sell is no longer valid.

If a call option is “in the money,” that means that the strike price is lower than the stock price, while a put option is “in the money” when the strike price is higher than the stock’s price. “Out-of-the money” options are the opposite, and “at the money” options have a value that’s roughly equal to their strike price.

The difference between options and futures is that options give traders the right to buy or sell but they are not obligated to do so. If the options contract doesn’t go the way the option buyer had hoped, they wouldn’t exercise their right and they would only lose the premium they paid upfront. There are many different options-trading strategies.

For example, some options traders use a straddle technique, which is a neutral options trading strategy creating the opportunity for an investor to profit whether the underlying asset goes up or down in price.

Investors may also sell naked options, in which they have not set aside the cash or underlying security to meet the obligation of the contract. If the option holder in that case decides to execute their option, the seller will need to buy the security or provide the cash that they now owe.

Futures

With futures derivatives, the buyer and seller set a price for the future exchange of an asset or commodity. The contract includes the price, the amount, and the future settlement date. The contract obligates them to execute on the transaction.

Only a small amount of the total asset value is deposited into one’s account, but a higher amount must be kept in the account to cover losses that might occur. Once the contract is entered into, the price of the underlying asset is tracked daily, and any gains or losses are added to or removed from the trader’s account until the contract is sold or expires.

There are specific futures exchanges set up to monitor and standardize futures trading. But some similar contracts known as forwards are sold in over-the-counter markets that are unregulated and allow for more negotiation.

Swaps

Swaps are contracts traded over the counter for the exchange of financial terms or cash flows such as interest rates and currencies. Companies can swap types of interest rates in order to get better terms. Oftentimes one rate is variable and the other rate is fixed. With currency swaps, companies can invest overseas with a lower risk of exchange rate fluctuations.

How Derivative Trading Works

A derivatives contract says that one will either earn or pay money related to the underlying asset. Although there is an initial deposit for the derivative contract, there is the risk of having to pay more depending on how the asset’s value shifts during the period of the contract.

There is additional risk involved in trading derivatives because there is a possibility that the losing party won’t pay the money owed, and this can lead to legal trouble as well. If there is a contract related to an unregulated market this can also be risky because there is potential for market manipulation.

Once a derivative contract is entered into, the buyer can either hold onto it until the expiration date when they purchase the asset at the agreed upon price, or they can sell the contract to someone else, potentially for a profit. Trading one derivative for another one prior to the contract end date is common. Generally the contract will sell for only a tiny amount of the value of the underlying asset, but the value of the contract can fluctuate along with asset price fluctuations.

There is a small down payment involved for entering into the contract, known as “paying on margin.” It’s typical for derivatives for stocks and market indexes to represent groups of 100 shares. For example, there could be a contract to purchase 100 shares of a stock for $3,000 per share, and the contract might trade at $3 per share per contract.

Before entering into a derivative contract, it’s important to understand how derivatives work and read what the contract entails, including the disclosure statement. There will be an agreement to sign stating that both parties have read and understand the terms.

Also, trading derivatives requires ongoing work and attention. Markets can change quickly and there may be obligations throughout the contract period such as tracking the value of the underlying asset.

Costs

When entering into a derivative contract, there may be a deposit and an initial fee, and there may also be a holding fee involved as well as additional hidden fees. Pricing for derivatives vary depending on the type and value of the underlying asset as well as the broader market for that derivative.

Pros and Cons of Trading Derivatives

There are several pros and cons to trading derivatives. Some of the main ones are:

Pros

Derivatives traders enjoy several advantages by using the financial instrument. Those include:

• A hedge against the risk of future losses

• An opportunity for speculation

• Exposure to an asset without having to purchase it

• Can help predict future cash flows

• Provides the ability to lock in prices

Cons

In addition to the advantages, there are several drawbacks that derivatives traders should understand.

• Trading derivatives is very complex and can be risky for inexperienced traders

• The derivative contract may not be liquid or easily sellable on the open market

• There is a risk of losing more than you invest, if you’re using naked options

• Online scams in derivatives trading are common, adding to the risk

• There are fees and costs associated with the contract

• There may be ongoing maintenance and time commitment required

Financial Derivatives Regulations

Regulations around derivatives depend on where they are traded. The Securities and Exchange Commission regulates derivatives traded on national securities exchanges, while over-the-counter derivatives may not have any regulating body.

In the latter case, the parties negotiate the terms of contracts on their own. Sometimes these parties include banks and financial institutions regulated by the SEC. Futures brokers and commercial traders must be registered with the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC).

The Chicago Board Options Exchange (CBOE) is the most well known options exchange platform and is regulated by the SEC. These regulating bodies help to prevent fraud and abusive trading practices and keep the markets running fairly and smoothly.

Start Investing Today with SoFi Invest

Derivatives can be a riskier type of investment but they can provide value to both institutional and retail investors’ portfolios when used wisely. Trading derivatives requires more work than simply buying and selling more traditional securities, but the additional risk and additional work can also yield greater rewards.

SoFi offers an intuitive and approachable options trading platform, thanks to its user-friendly design and the educational resources about options it provides. Investors can trade options from the mobile app or the web platform, depending on their preference.

Pay low fees when you start options trading with SoFi.

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Mar

2022

Forex Binary Options, Explained: What They Are & How They Work

By Dan Miller | Growing Wealth, invest, Investing, Terminology | Comments Off

If you have experience trading options in the stock market, you may also be interested in trading options in the forex world. Forex (short for foreign exchange) is a trading market separate from the stock market where traders buy and sell different types of foreign currency.

Two parties might exchange currency if one is traveling in a different country or part of a multinational company. Many people also trade foreign currency as an investment, just as people do with the stock market.

Binary options, also known as digital options, are one way to trade in the foreign currency market. This all-or-nothing investment option can be attractive to some traders. Below, we’ll explore how binary options work and why one might choose to trade them.

What Are Binary Options?

Binary options are one of the more exotic options out there. With a binary option, you set a currency pair (like USD/EUR), a strike price, and a timeframe. Both the buyer and the seller put down their money upfront. Binary options are typically priced from 0 to 100, and the price represents the approximate probability that the given currency pair will be at or above the strike price when the option expires.

How Do Forex Binary Options Work?

Unlike traditional call and put options in the stock market, forex binary options have only two possible outcomes: if you’re on the right side of the strike price, you make money, and if you’re on the “wrong” side of it, you lose money.

For example, if an option is priced at 40, then the buyer must pay $40 per contract and the seller must pay $60 ($100 – the $40 price) upfront. When the option closes, whichever side is on the right side of the strike price collects the entire $100. The fact that there are only two possibilities leads to the name binary option.

Pros and Cons of Forex Binary Options Trading

Here are some of the pros and cons of trading binary options when forex trading:

Pros	Cons
Limited and defined risk	More expensive than traditional forex trading
Can trade even with a smaller budget	Supported by a limited number of brokers
Easier to understand since there are only two possible outcomes	Even as a seller, you must put your money down upfront
	100% loss of your position if you are wrong

Binary Option Risks and Rewards

Like all investments, investing in binary forex options comes with risks and rewards. These risks and rewards are different for the buyer and seller.

Risk for Buyers

While there is risk in trading binary options, a trader knows the amount of money they’re risking upfront. With a binary option, you put down a specific amount of money (the option price). If the currency is below the strike price at expiration, you will lose all of the money you put down.

Reward for Buyers

The potential rewards for a buyer purchasing a binary option are set when the option contract is set. If the currency is at or above the strike price at expiration, you will get the total amount of the contract (usually $100).

Risk For Sellers

The risk for sellers of a binary forex option is known when the contract is agreed upon. Unlike sellers of traditional options in the stock market, sellers of binary options must put their money down upfront. This is usually $100 minus the price of the contract. If the option closes at or above the strike price, the option seller will lose all of the money they put down.

Reward for Sellers

On the other hand, if the currency closes below the strike price at expiration, the option will expire worthless and the seller will collect the entire $100. This could be a significant percentage gain, depending on how much was put down originally.

Binary Option in Forex Examples

Here are a few examples of how you could use a binary option in forex trading:

• EUR/USD binary option for 1.15 closing in one hour, trading at 30. A buyer would need to put down $30 and the seller $70, per contract. If the price of Euros is at or above 1.15 dollars in one hour, the buyer will collect $100. Otherwise the seller will take $100.

• AUS/JPY binary option for 83 closing next Friday, trading at 75. A buyer would put down $75 and the seller of this option would put down $25 per contract. If the price of the Australian dollar is at or above 83 yen, the buyer would take $100. If it is below 83 yen, the seller would collect the entire $100, minus commissions.

The Takeaway

Binary options are a way to invest in the foreign currency market. At its simplest, a binary option is a bet on the ratio of two different currencies. With a binary option, both the buyer and seller put down their money upfront. At expiration, whichever side is on the correct side of the strike price collects the entire premium put down (usually $100 per contract). Binary options can be incredibly risky because you have to be right on the direction of the move, the magnitude and the timing.

To guide your options trading platform, it can be helpful to use a platform like SoFi that offers educational resources about options. What’s more, SoFi’s options trading platform has an intuitive and approachable design that gives investors the ability to make trades from the mobile app or the web platform.

Trade options with low fees through SoFi.

FAQ

Are forex and binary options the same thing?

If you are comparing options vs. forex, you may be wondering what the difference is between forex and binary options. The two terms are similar in that they both refer to trading on the foreign currency markets, but they are slightly different. Forex refers usually to buying and selling the actual currency itself, while binary options allow you to invest in forex for a smaller budget with more leverage.

Are binary options better than forex?

Binary options are a particular kind of currency option that have only two possible outcomes. They come with their own set of risks and rewards. Which one is better will depend on your personal risk tolerance and knowledge of the foreign currency markets.

Can you trade binary options on forex?

Yes, binary options are typically traded in foreign currency pairs (like EUR/USD or AUS/JPY). Binary options give you an additional way to speculate or trade on movements in the foreign currency markets.

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Mar

2022

What Is Time in Force? Definition and Examples

By Dan Miller | Growing Wealth, invest, Investing, Terminology | Comments Off

Time in Force is a stock investing term referring to the length for which a trading order is good. While casual or buy-and-hold investors may not use time-in-force stock limits, they’re an important tool for active traders.

Understanding different time-in-force options can help you close out more successful positions.

What Does Time in Force Mean?

Time-in-Force is a directive, set by a trader, that defines how long a trade will remain open or “in force” before expiring. Options traders and other active traders typically want to set an appropriate end date for trades to avoid unintended trade execution. This is especially true for investors employing day trading strategies and taking advantage of volatile market conditions with rapidly changing prices.

Recommended: Understanding the Risks of Day Trading

Basics of Time In Force

Before you place a Time-in-Force stock order, you’ll want to make sure that you understand exactly how they work. As with options trading terminology, it’s important to understand the language used to describe Time-in-Force orders.

Recommended: A Guide to Trading Options

Types of Time in Force Orders

There is no specific type of stock market order called “Time in Force”. Instead, the phrase refers to the collection of order types that set how long a trade order is valid, or “in force” in order to take advantage of investment opportunities. If you are considering a buy-to-open or buy-to-close order, you can also specify the time in force for either of those types of orders.

Not all brokers or dealers support every different kind of time in force order, but here is a look at several of the most common types of time in force stock market orders.

1. Day Order

This is the most common time-in-force order, and means the trade remains open until the end of the trading day. If your order has not been executed at the close of the day’s markets, it will expire. With many brokers, day orders represent the default option, and as such, this is the time in force order with which most people are likely familiar.

2. On-Open Order

Depending on the types of order that your broker or dealer offers, there can be two different types of time-in-force-on-the-open orders.

A market-on-open (MOO) order is an order filled when the market opens, at the prevailing opening price. With a Limit-on-Open (LOO) order, you can set a limit price for the highest price you’ll pay or the lowest price at which you’ll sell. If the market opens within the constraints of your limit order, it will be executed. Otherwise, your broker will cancel the LOO order.

3. Market on Close Order

A Market-on-Close (MOC) order is one that requests the sale or purchase of a security at the final closing price of the trading day. If your brokerage offers market-on-close orders, they will generally have a cutoff time by which you need to enter in any MOC orders.

Recommended: Buy to Open vs. Buy to Close

4. What Is Good ‘Til Canceled (GTC)?

As its name suggests, a good-til-canceled (GTC) order is a type of time-in-force order that remains in force until you proactively cancel the order or it is filled. Depending on the type of options strategy you’re employing, a good-to-cancel order can make a lot of sense, if you’re waiting for a moment in the underlying stock price. Many brokerages will restrict the number of days a good-to-cancel order will be open, often to 90 days.

Examples of Time in Force

You currently own 100 shares of ABC stock that you purchased at $20 per share. ABC stock announced earnings last night, and you’re considering liquidating your position. You’re not sure how the market will react to the earnings news, so you place a Limit-on-Open (LOO) order for $30 per share. If ABC stock opens at $30 or higher, your trade will execute, otherwise your broker will cancel it.

If ABC stock’s shares have been rising all day, but you expect them to open at a lower price, you might use a market-on-close order in order to try to sell at the high price at the end of the day. If you want to hold onto your ABC stocks until they reach $40 per share, you could set a good-til-canceled order to do so. Your order would automatically execute when shares hit $40, or it would expire after reaching your broker’s time limit for such orders, typically 90 days.

Time in Force Day Order vs On-Close Order

A Day order and an On-Close order are similar, but they have some important differences. A Day order is one that is good for the entire trading day, up to and including close. If you’re placing an order in the middle of the trading day and don’t care when it executes, this is the type of order you’d use.

On the other hand, an On-Close order (either Market on Close or Limit On Close) is only good at the close of the trading day. The intent of an On Close order is to execute at the final trading price of the day. If you place an On Close order in the middle of the trading day, it will not execute until the end of the trading day, regardless of the price throughout the day.

Using Time in Force Orders

How you use the different Time-in-Force orders will depend on your options trading strategy. Most buy-and-hold investors won’t use Time-in-Force orders at all, but if you’re using a more complex strategy, such as buying to cover, you may want to have more control over how and at what price your order is executed.

Start Trading With SoFi

Using time-in-force orders can help day traders execute on specific strategies and minimize potential offers. It determines how long a trade will remain open before being canceled. Most long-term investors do not use time-in-force orders.

If you’re ready to start options trading one way to get started is with SoFi’s options trading platform. This user-friendly platform boasts an intuitive design, and you can make trades from either the mobile app or web platform. Plus, there’s a library of educational content available for reference.

Trade options with low fees through SoFi.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

Feb

2022

What Is a Bear Call Spread? How It Works

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Like other aggressively-named options trading strategies, the bear call spread has more to do with numbers and market timing than it does with fur and fangs (or horns). But it’s yet another options trading strategy that can help you beef up your returns.

If you’re an options trader — or an aspiring one — you likely know many of the common strategies for trading options, including calls, puts, and bull put spreads.

But options strategies can get very complicated, very fast — and the bear call spread is no different. Here’s what to know about the bear call spread and how it works.

What is a Bear Call Spread?

A bear call spread is one of four basic vertical options spreads that traders put to regular use. It is the opposite of a bull call spread, and it’s particularly useful if you’re anticipating a bear market.

A trader utilizing a bear call spread strategy is trying to capitalize on a decrease in value of the option’s underlying asset. Hence, the “bear” in the strategy’s name. And as such, a trader would use a bear call spread only in the instance that they believed the underlying asset’s value was going to fall.

How Does a Bear Call Spread Work?

A trader creates a spread by buying and selling two call options at the same time, attached to the same underlying asset, with the same expiration date. The key difference is that the two call options have different strike prices. One call option one is a long call option strategy, and the other is short (similar to shorting a stock), with the short call having a lower strike price than the long call.

When the trader simultaneously purchases a long call and sells a short call (with a lower strike price), it creates a credit in the trader’s account, since the calls the trader is buying are less expensive than the calls the trader is selling. The short call generates income for the trader by creating a premium, and the long call helps limit the trader’s risk.

Setting up these two positions creates a spread, and the trader benefits when the underlying asset’s value declines. The maximum potential profit is capped at the value of the premium received.

If the underlying asset’s value increases, the spread can become a loser for the trader — but that maximum potential loss is capped at the difference between the strike prices of the two options, minus the premium.

Example of a Bear Call Spread Strategy

As an example, in its simplest form a bear call spread could involve a trader selling a short call option on stock XYZ, which expires in one month, with a strike price of $10, for a premium of $2. Simultaneously, they buy a call option with the same expiration and a strike price of $12 for a premium of $1. By selling the short calls, they’ve received a net premium of $1. Since an option contract typically controls 100 shares, their total credit is $100.

With that, a bear call spread has been set up. The trader has two calls with the same expiration date, but two different strike prices. The short call’s strike price is less than the long call’s strike price.

To continue this example, let’s say a month goes by, and the trader’s bearish instincts have proven correct. Stock XYZ’s price declines and their call options expire below the $10 strike price of the short call. They keep the net premium of $100, and walk away with a profit.

We should also consider the downside scenario where the stock price does not move in the trader’s favor. Suppose instead that XYZ climbs to $13 on expiration day. The trader closes out both contracts for a net loss of $2 per share, or $200 for each set of contracts. This is offset by the $100 they received upfront, so their net loss is just $100.

Finally, let’s analyze the breakeven point. This will occur at the strike price of the short call, plus the net premium received. In our example, the $10 lower strike, plus $1 of net premium, or $11.

Advantages & Disadvantages of a Bear Call Spread

Advantages	Disadvantages
Flexibility	Capped potential gains
Capped potential losses	Limited potential use
Relative simplicity	The strategy could backfire completely

Advantages of a Bear Call Spread

There are some advantages to bear call spreads, which is why some traders use them to pad their returns.

• Flexibility: There is a lot of wiggle room for traders in how they set up the strategy. Depending on the specific calls sold and purchased, traders can see a profit under a variety of scenarios, such as when the underlying asset’s value remains the same, or when it declines.

• Capped potential losses: There’s a maximum that a trader can lose, and that can be comforting to some. These types of strategies are used not only to increase profits, but to limit risk, and limiting risk can be a very attractive attribute in a volatile market.

• Relative simplicity: When you think about it, traders are really just making two transactions: Buying a call option, and selling another. Given that other options trading strategies involve even more moving parts, the fact that a bear call spread only requires two moves at the onset can be advantageous to some traders.

Disadvantages of a Bear Call Spread

Bear call spreads can have their disadvantages.

• Capped potential gains. Like other vertical spread strategies, potential gains are capped — in this case, at the initial net premium credited to the account.

• Limited potential use. The strategy is best used when dealing with assets that are volatile and that may experience a decline in value. It’s hard to say when, or if, the right market conditions and an appropriate asset align in such a way that a trader would use the strategy to profit.

• The strategy could backfire completely. The risk is that the underlying asset sees a dramatic rise in value, rather than a fall in value, as the trader predicted, blowing up their short call. This could mean that the trader has to buy the underlying asset at market value, potentially leading to a loss.

Bear Call Spread Considerations and Tips

There are a few other things worth keeping in mind when it comes to the bear call spread strategy.

• There’s an early assignment risk. Since options can be exercised at any time, traders with short option positions should remember that they’re putting themselves at risk of early assignment — or, the trader needs to fulfill their obligation and may need to buy the underlying asset to do so.

• The strategy can be used in variations. A bear call spread is only one of several vertical options spreads that traders can put to use. Depending on market conditions, it may be wise to use a bullish strategy instead.

• This is all speculative! It’s critical to remember that options trading is speculative. There are no guarantees, and the risk of loss is real. No matter how good any trader thinks they are at predicting the market, things can go sideways at any point. It’s important for investors to calculate the risk-reward ratio before choosing their speculative tools.

The Takeaway

The bear call spread is one of many options trading strategies a trader may employ in trying to reap as much profit from their investments as possible. But as with all strategies, it is not foolproof, and positive results are never guaranteed.

When getting started with trading options, it can help to have educational resources about options on hand and a user-friendly platform, both of which SoFi offers. With SoFi, investors can trade options from the mobile app or the web platform.

Trade options with low fees through SoFi.

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