If you feel like the market is due for a pause here, then you’re in luck, as there is still a way to profit using options.
In this article, we'll show you two bear call spread trades you can make this Wednesday.
A bear call spread is a type of vertical spread, meaning that two options within the same expiry month are being traded.
One call option is being sold, which generates a credit for the trader. Another call option is bought to provide protection against an adverse move.
The sold call is always closer to the stock price than the bought call.
As the name suggests, this trade does best when the stock declines after the trade is open.
However, there can be many cases where this trade can make a profit if the stock stays flat and even if it rises slightly.
Bear call spreads are risk defined trades. There are no naked options here, so they can be traded in retirement accounts such as an IRA.
Traders should have a bearish outlook on the stock and ideally look to enter when the stock has a high implied volatility rank.
Two stocks came up on my screens today as possible bear call spread candidates.
Two Bear Call Spread Candidates
Starbucks (SBUX) is sitting below the 21, 50 and 200-day moving averages and the Barchart Technical Opinion rating is a 100% Sell with a Strongest short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
Looking at the chart there are plenty of areas of potential resistance around 90.
Starbucks Corp. is a roaster and retailer of specialty coffee globally. Besides its fresh, rich-brewed coffees, the company's offerings include many complimentary food items and a selection of premium teas and other beverages, sold mainly through the company's retail stores.
The company's popular brands include Starbucks coffee, Teavana tea, Seattle's Best Coffee, La Boulange bakery products and Evolution Fresh juices.
Other than the company's own retail stores, it generates revenues through licensed stores, consumer packaged goods and foodservice operations.
The company receives royalties and license fees from the U.S. and international licensed stores.
Under its consumer packaged goods operations, Starbucks sells packed coffee and tea products as well as a variety of ready-to-drink beverages and single-serve coffee and tea products to grocery, warehouse clubs and specialty retail stores.
The company's latest reportable operating segments comprise North America, International and Channel Development.
Implied volatility is high at around 41.31% giving Starbucks an IV Percentile of 92%.
Let’s look at how a bear call spread trade might be set up on SBUX stock.
SBUX Bear Call Spread: November $90 – $95 Bear Call Spread
As a reminder, A bear call spread is a defined risk option strategy that profits if the stock closes below the short strike at expiry.
To execute a bear call spread an investor would sell an out-of-the-money call and then buy a further out-of-the-money call. You can find ideas like this using the bear call spread screener.
This particular idea involves selling the November expiry $90 strike call and buying the $95 strike call.
Selling this spread results in a credit of around $0.68 or $68 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
5 – 0.68 x 100 = $432.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 15.74%.
The spread will achieve the maximum profit if SBUX closes below $90 on November 21, in which case the entire spread would expire worthless allowing the premium seller to keep the $68 option premium.
The maximum loss will occur if SBUX closes above $95 on November 21, which would see the premium seller lose $432 on the trade.
The breakeven point for the bear call spread is $90.68 which is calculated as $90 plus the $0.68 option premium per contract.
Let’s look at another idea, this time on Salesforce (CRM) which was another stock that came up on my bearish scans.
CRM Bear Call Spread: November $260 – $270 Bear Call Spread
This bear call spread trade also involves using the November expiration on CRM and selling the 260-270 call spread.
Selling this spread results in a credit of around $1.80 or $180 per contract. That is also the maximum possible gain on the trade. The maximum potential loss can be calculated by taking the spread width, less the premium received and multiplying by 100. That give us:
10 – 1.80 x 100 = $820.
If we take the maximum gain divided by the maximum loss, we see the trade has a return potential of 21.95%.
The spread will achieve the maximum profit if CRM closes below $260 on November 21, in which case the entire spread would expire worthless allowing the premium seller to keep the $180 option premium.
The maximum loss will occur if CRM closes above $270 on November 21, which would see the premium seller lose $820 on the trade.
The breakeven point for the bear call spread is $261.80 which is calculated as $260 plus the $1.80 option premium per contract.
Mitigating Risk
With any option trade, it’s important to have a plan in place on how you will manage the trade if it moves against you.
For the SBUX bear call spread, I would set a stop loss if the stock traded above $90.
For the CRM trade, I would close for a loss if the stock broke through $250.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
