Equity and Index Options Explained

15

Short Call Spreads (Bear Call Spreads)

Remember, a call spread consists of two legs, a long call and a short call. We have already seen that a long call spread, sometimes called a bull call spread (because it is bullish in nature), consists of a long call with a lower strike and a short call with a higher strike. A short call spread, sometimes called a bear call spread (because it is bearish in nature), consists of a short call with a lower strike and a long call with a higher strike.

For example, from the matrix of Sep BP option prices in Table 15.1, selling the 540/560 call spread consists of two legs, selling the 540 call at 19 and simultaneously buying the 560 call at 12. The price of the call spread is 7 ticks (equivalent to £70 per spread), the difference between the 19 received from the sale of the 540 call and the 12 paid out for the 560 call. These 7 ticks represent the maximum profit on selling the call spread. If BP is at or below 540 (i.e. £5.40) on Sep expiry, then both the 540 and 560 calls will expire worthless. The maximum possible value of the call spread is 20, the difference between the two strike prices of 540 and 560. If BP is at or above 560 (i.e. £5.60) on Sep expiry, then the 540 call will be worth exactly 20 more than the 560 call.

Given that the maximum possible value of the call spread is 20 and that the price received for the call spread is 7, the maximum possible loss is 13, the difference between the maximum value of the spread and its price.