When an investor is feeling bearish on the market, another good stock option trading strategy to employ is Selling Calls or Selling Bear Calls. This method is also known by the name Vertical Bear Calls. This is considered a bearish strategy because the trader profits if the underlying stock decreases in value. Basically, the strategy is to buy out-of-the-money call options and sell in-the-money call options on the same stock with the same expiration date. The plan is that the in-the-money stock closes lower than its strike price at its expiration date, and then the trader realizes maximum profits from selling calls.
When selling calls, the investor will experience maximum loss when the stock price increases above the higher, out-of-the-money call option strike price at the expiration date. This loss will be the difference between the two strike prices minus the net credit of the spread when it was originated. While there is risk involved, this stock investing concept allows investors to find profits even when the market is bearish by selling calls.
The downside of selling calls is that, while it is lower risk than simply buying put options, it has a limited profit potential as well. The break-even is at the lower strike price plus net credit. The maximum profit potential is when the stock decreases below the in-the-money call option strike price. In such cases, the investor will review his / her stock trading plan to see if the data and potential risks of the strategy are likely to create successful trading when selling a call.
For example, an investor wants to sell calls on ABC, Corp. The stock price is $39.875. The trader sells an in-the-money call option with a June expiration at a strike price of $35 for $5. At the same time, the investor buys a out-of-the-money call option with a June expiration at a strike price of $40 for $1.56. Selling a call such as this is a net credit of $3.44, spread of $5, or the difference between the costs of the two options. If the stock price is lower the in-the-money strike price on the expiration date, this would be a maximum profit of the net credit when selling the calls: $5.00 – $1.56= $3.44 x 1 contract (100 shares) for a maximum profit of $344. Conversely, the maximum loss would be if the stock closed above the out-of-the-money strike price on its expiration date: $5.00 Call Spread – $3.44 net credit received = $1.56 x 1 contract for a maximum loss of $156.00. Because the risk is low, the risk reward ratios when selling calls are still very good.
A successful trader will adequately investigate such a move prior to selling calls. That way, he / she can be assured that the trade has a high probability of being successful. As with any trade, the investor needs to understand the risks and potential profits involved in order to make a wise decision. Using a stock trading system such as Japanese Candlesticks, the investor has access to charts that are understandable and powerful data in the attempt to sell calls to make a profit.
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