Hey everyone. This is Kirk here again from Option Alpha and in this video, we’re going to walk through a bear call spread breakeven price calculation. You might also hear people call this a short call spread as well or if you see other places, they might call this a call credit spread. It’s all the same stuff essentially. It’s just different names that they’re using. Bear call spread, a short call spread or a short call credit spread, again, it’s all essentially the same stuff. We’re going to walk through it here, so you understand how to calculate your breakeven price which is important to know not only just because you want to know where your breakeven price is, but also because it’s important to know where the breakeven is for the purposes of eventually calculating probabilities which we do in other videos. We’re going to setup this framework here which is basically the framework for our payoff diagram. And again, this zero line is in the middle and then you got your positive values where you make money and your negative values where you lose money. A bear call spread essentially looks like this. This is a payoff diagram of a bear call spread. And so, down this horizontal line here, you have all of the different stock prices. In this case, if you’re selling a bear call spread, this first place where the stock pivots, that is where you short a call option at some strike price. In our case, let’s say we sell a call option at a 90 strike price and that’s where the payoff diagram here first pivots and heads lower. The other place where the payoff diagram pivots is at this point, and at that point, that’s where you’re buying a call option contract at a higher strike price. Let’s say we buy a call option contract at a 92 strike. Now, remember, the stock right now could be trading somewhere down here. Maybe the stock is trading at $80 a share, somewhere down in that level. You’re selling this bear call spread, anticipating either the stock stays lower or potentially goes a little bit higher, but what you’re trying to figure out is you’re trying to figure out what this price point is right here. What’s the price point that is your breakeven to figure out where you make money or you don’t make money based on all the credits and debits and things like that that you’ve collected on this position.
It’s pretty simple to calculate this breakeven point on a bear call spread, but we do need to figure out a couple different things. The first thing that we generally need to know is what is the difference and net credit that we collected on this position when we entered the strategy. When you’re selling a bear call spread, you’re usually doing it hopefully for a net credit. That’s how they’re built. We need to know what the net credit is between these two contracts. Now, you can look at the individual contracts and say, “Okay. This contract is $.50 and this contract was $1, so if I sold this for a $1 and I spent $.50 for this contract, that means that my net credit is simply $.50 on the position. That’s how much I took in net of the different contracts that I used to purchase and sell to get into the bear call spread.” That net credit is really important because that net credit is what we used to then figure out where our breakeven point is on this position. Now, the calculation for this is actually pretty easy when you use a bear call spread. All you’re going to do is you’re going to take the strike price of the short call option contract which is here (that strike price was $90) and you’re going to add the net credit that you collected from the bear call spread position which in our case is $.50 for this example. That gives you your breakeven point of $90.50. That is the breakeven point that you see right there, so that means that the stock essentially can rally up to $90.50 and once it gets to $90.50, that’s your breakeven point where you don’t make any money or lose any money at expiration. Anything after that, of course, you start losing until the point at which you lose your max risk on the position. It’s pretty simple to do. Again, you just take the short call strike of the position that you just sold on the bear call spread, you add the credit that you received net of all the other contracts that you had purchased, you add those two together and that gives you your breakeven point for a bear call spread. As always, if you guys have any questions, let us know and until next time, happy trading.
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