InvestZ Archives | Page 157 of 163

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.

Photo credit: iStock/simonapilolla

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
SOIN0221021

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.

Photo credit: iStock/Tatomm

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
SOIN1121490

Feb

2022

Bollinger Bands Explained

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

What Are Bollinger Bands?

Bollinger Bands® are popular tools used in technical analysis of securities. They are a set of three bands that measure the relative high or low of a security’s price in relation to previous trades.

These defined trend lines are the simple moving average (SMA) of the price of the security plus plotted lines two standard deviations away from the SMA. The bands are plotted positively and negatively from the SMA, which measures the volatility of a security, and the trader can adjust them based on their particular use case. When the security becomes more volatile the bands widen, when it becomes less volatile they get closer together.

Bollinger Bands were created to help investors understand whether a security is currently oversold or overbought, to help determine whether it is likely to increase or decrease in value over time. When the upper band is close to the SMA, generally traders see this as an overbought security. When the lower band is close to the SMA, the security is considered to be oversold.

The bands and a set of 22 rules about using them for trading were developed in the 1980s by John Bollinger, a well-known technical trader.

How Do Bollinger Bands Work?

Bollinger Bands are plotted using two parameters, period and standard deviation.

Period is found by calculating the simple moving average of the security a trader is interested in. The calculation generally uses a 20-day SMA, an average of a security’s closing prices over a 20 day period — or roughly a month of trading days. The first data point on the graph would be the average of the first 20 days being tracked. The second data point would be the next 20 days, and so on.

That line shows the SMA over time, and the Bollinger Bands are then placed above and below it by calculating the standard deviation of the security’s price along each data point. The standard deviation is a calculation of the average variance of the SMA value, which shows how far apart values are from the SMA.

The standard deviation is calculated by first finding the square root of the variance, which is the average of the squared differences of the mean. After finding the square root of the variance, that number is generally multiplied by two, although the number can be adjusted. The resulting value is then added and subtracted from each SMA data point to form the upper and lower Bollinger Bands.

Key Things to Know About Bollinger Bands

A few key things to understand about Bollinger Bands:

• When volatility is low, the bands get closer together. This indicates that volatility may increase in the future and therefore there could be a significant price movement up or down.

• When volatility is high, the bands get farther apart. This indicates that an existing price trend could be coming to a close in the future.

• Generally the security’s price movements stay within the two bands. And once they touch one band they start moving towards the other band. But the price can also bounce off the band multiple times or it can cross over the band. If the price hits one of the bands and then crosses over the SMA line, that is an indicator that it is heading toward the opposite band’s price level.

When the price crosses to the outside of the bands, this is a strong indicator of a trend in that direction.

Formula for Bollinger Bands

Below is the formula to plot Bollinger Bands:

BOLU=MA(TP,n)+m∗σ[TP,n]

BOLD=MA(TP,n)−m∗σ[TP,n]

where:

BOLU=Upper Bollinger Band

BOLD=Lower Bollinger Band

MA=Moving average

TP (typical price)=(High+Low+Close)÷3

n=Number of days in smoothing period (typically 20)

m=Number of standard deviations (typically 2)

σ[TP,n]=Standard Deviation over last n periods of TP

How Do You Read Bollinger Bands?

Bollinger Bands help traders understand whether a security’s price is relatively high or low so that they might make trades based on trends. Bollinger Bands can indicate uptrends and downtrends as well as possible upcoming price reversals.

Trends can last for minutes, hours, days, weeks, months, and even years, so traders should understand how to set up the bands based on the timeline of their trading strategy. Here are some patterns and indicators traders might want to learn.

Uptrends

Traders can use Bollinger Bands to see whether there is a bullish trend in a security’s market price. If the center line hits the upper band multiple times, this indicates an uptrend. If the price hits the upper band, decreases but stays above the center line, then hits the upper band again, that is a strong indicator of an uptrend. If the price then hits the lower band, it may indicate a reversal or a loss of strength in the uptrend.

Downtrends

The lower band can indicate a downtrend or an upcoming reversal towards an uptrend. If the price hits the lower band continuously and stays below the center line, this indicates a downtrend. Traders typically avoid making trades during downtrends, but if there is an indicator of a reversal they might choose to buy.

The Squeeze

When the bands are close together, this is known as a squeeze. The squeeze happens when the security has low volatility, but it indicates that the security will probably have increased volatility in the future. Traders look for high volatility periods to find trading opportunities, so the squeeze indicates that those opportunities may be showing up soon.

Traders typically like to exit trades during periods of lower volatility, so they look for far-apart bands as a clue that volatility may soon decrease. The squeeze is not used as a trading signal and doesn’t show whether a security will increase or decrease in value, but it may help traders figure out the potential timing of upcoming trades.

Breakouts

The SMA line doesn’t always stay between the Bollinger Bands — it can also move above or below the bands. Around 90% of price changes do happen between the bands, so if the price has a breakout above or below the bands it’s a significant event. However, breakouts are not used as trading signals and are not indicators that the security price will move in a particular direction in the future.

Bollinger Band Trading Strategies

Financial analyst Arthur Merrill, who identified a set of 16 trend patterns that have M patterns and W patterns. Here are two key patterns.

M Top

The M top pattern indicates that the security price may decrease to a new low. It forms an M pattern at the upper band, where the price nearly hits or hits the upper band but doesn’t cross over it, then decreases to below the low in the center of the M pattern.

W Bottoms

W patterns can be used to identify W Bottoms, which is when the second low is lower than the first low but neither low goes below the lower band. If the security rises above the high in the center of the W, this is an indicator that the price will likely reach a new high.

Combining Bollinger Bands With Other Indicators

John Bollinger recommended that traders use Bollinger Bands in conjunction with other non-correlated indicators, such as the relative strength indicator (RSI) and the Stochastic Oscillator, in order to gain a comprehensive understanding of the security being assessed. While Bollinger Bands help traders understand price volatility and can show opportunities for upcoming trades, they aren’t strong indicators of potential upcoming price movements.

Drawbacks of Bollinger Bands

There are a number of caveats to consider when it comes to Bollinger Bands. In particular, they are best used with other stock indicators, to form a fuller picture.

• They show old security price data with equal importance to new data, so data that is outdated may be counted with too much importance.

• They are more of reactive indicators than predictive indicators, so they show current market conditions and can indicate trends, but are not strong indicators of what will happen to a security’s price in the future.

• The standard settings of 20-day SMA and 2 standard deviations is an arbitrary measurement that doesn’t convey relevant information for every security and trading situation, so it’s important that traders understand how to adjust the band calculations for their particular situation.

Using Bollinger Bands for Crypto Trading

Bollinger Bands have become a popular tool for crypto traders to track volatility and trends. They can be used for trading crypto in a similar way to stocks, but some traders choose to use a 28 or 30 SMA instead of 20, to better represent a month of trading days, since the crypto markets are open 24/7.

The Takeaway

Bollinger Bands are a useful tool for technical analysis of stocks, which measure the relative high or low of a security’s price in relation to previous trades over typically the past 20 trading days. One of many trend indicators, Bollinger Bands are also sometimes used in crypto trading.

If you’re looking to get started trading options, SoFi offers an intuitive and approachable options trading platform. Investors are able to make trades from the mobile app or web platform, and they can access a library of educational resources about options.

Trade options with low fees through SoFi.

Photo credit: iStock/blackCAT

SoFi Invest®

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

Feb

2022

What Is Buy to Cover & How Does It Work?

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

Buy to cover refers to when investors purchase shares in a stock that they had previously shorted. This is a form of margin trading that involves higher risk than more traditional buying and selling.

In this article, we’ll take a look at the buy to cover order, how it fits into short selling and margin trading, and when you might want to use a buy to cover order.

Buy to Cover Meaning

Traditionally, you buy a stock on which you have a bullish outlook, and sell to close out your position. In an ideal situation, you buy low and sell high, securing the difference between the purchase price and the sale price as your profit. If you think a stock is currently overpriced, you might sell the stock before you have actually purchased it, via a short sale. This requires temporarily borrowing the shares, usually from your broker or dealer. Then, once the stock (hopefully) goes down, you purchase the shares, closing out your position.

Buying to cover is that after-the-fact purchase of shares that you previously shorted. When you do a short sale by selling first, you will eventually need to repay your short sale by purchasing shares.

What Is a Buy to Cover Limit?

When placing a buy-to-cover order, there are two ways that you can close your position. The first is a market order, in which you simply close the position at the first available market price. The other method involves using a buy-to-cover limit order, in which you set a maximum price at which you’re willing to purchase the share.

One advantage of the latter approach is that you know exactly the price that you’ll get for your shares. This can help you when planning your overall strategy. A drawback, however, is that if the market moves against you, your order may not get filled.

How Does Buy to Cover Work?

A buy-to-cover order works much in the same way as a traditional buy order. The main difference is the order in which you make your buy and sell transactions. In a traditional buy order, you purchase shares that you intend to later sell. With a buy-to-cover order, you’re buying shares to cover a sale that you previously made.

Example of a Buy to Cover Stock

Here’s a buy to cover stock example to help illustrate how the process works:

• Let’s say that you think stock ABC is overpriced at $50.

• You sell short 100 shares of ABC, borrowing $5,000 on margin from your broker.

• After a few days, stock ABC’s price has dropped to $45.

• You issue a buy to cover order for 100 shares of ABC, paying $4,500.

• Your profit is $500 — the difference between the amount you receive from the short sale and the amount you pay to close the position.

Sell Short vs Buy to Cover

“Selling short” and “buying to cover” are two sides of the same transaction. If you think that a particular stock or investment is likely to go down in price, you can use a short sale to first sell shares that you’ve borrowed on margin, generally from your broker or dealer.

When you’re ready to close out your short sale transaction, you can place a buy-to-cover order. This will purchase the shares that you sold originally, either at the market price or with a buy-to-cover limit order at a particular price. If the stock has gone down in price as you expected, you will profit from selling high and then buying low.

Buy to Cover and Margin Trades

Using a buy to cover order is intricately tied in with both short selling and margin trading. When you sell short, you are using margin trading to borrow shares to sell that you don’t yet own.

When you are ready to close out your position, you issue a buy-to-cover order, purchasing the shares you need to correspond to the shares that you earlier sold on margin. Keep in mind that if the stock moves against you after your short sale (the stock’s price goes up instead of down), you face a margin call, in which your broker forces you to either liquidate your position or add extra money to cover your position.

The Takeaway

A buy to cover is a purchase order executed to close out a short sale position. In a traditional sale, you purchase a stock first and then later sell the shares. When you sell short, you place a buy-to-cover order to close your position.

Trading options can be tricky, so it’s important to study up as you invest, which is where an options trading platform like SoFi’s comes in handy. It provides access to a library of educational resources about options. Plus, the platform’s intuitive and approachable design gives investors the ability to trade options from the mobile or web platform.

Trade options with low fees through SoFi.

Photo credit: iStock/Ridofranz

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
SOIN1121489

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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