When crypto prices plummet and panic permeates the air, it's tough for traders to think logically about portfolio management. Even the most committed crypto HODLers sometimes feel the urge to panic sell positions to avoid further drawdowns. Although hope grows dim during extended crypto winters, there are strategies to take the sting out of even the sharpest price dips.
Enter the bear call spread, which gives traders a way to practice risk management and profit when coins like Bitcoin (BTC) or Ethereum (ETH) hit multiyear lows.
In this guide, we’ll review the bear call spread strategy, how it works, and its advantages and disadvantages.
What is a bear call spread in crypto?
A bear call spread is a short-term derivatives strategy where traders buy and sell a pair of call options when they expect the underlying cryptocurrency's price to drop or stay flat. This technique is also called a call credit spread since crypto traders receive money (or credit) when entering this trade rather than paying a debit to open the position.
The initial credit from a bear call spread comes from the difference in premiums for the two call options. While both options in a bear call spread have the same expiration date, they don't have the same strike price for the cryptocurrency. Traders profit by selling a call option at a strike price either at or slightly above the cryptocurrency's current value and buying another out-of-the-money (OTM) call option with a higher strike.
Traders claim money upfront when using a bear call spread, receiving their maximum profit potential at the start of this trade. If the cryptocurrency drops below the break-even price by expiration, crypto traders get to keep their profits from the premium as the options expire worthless. Conversely, if the crypto price is above the break-even price when the options expire, both options go into effect, and traders need to pay the difference in premiums.
How bear call spreads work: Explaining with a bear call spread example
A bear call spread is a "two-leg" option strategy, meaning there are two parts to entering this trade. The first leg is to sell (or short) a call option with a strike price above the cryptocurrency's market price. Next, traders buy a call option for the same cryptocurrency with the same expiration at a higher strike price. Because the first option is closer to the cryptocurrency's current price, it has a greater probability of success for bullish traders, so the premium is higher in the derivatives market.
Let’s take a look at an example.
Suppose Bitcoin's price is $40,000, and a trader believes BTC will decline or trade sideways for the next month. To exploit this price decline, the trader sells a Bitcoin call contract with a strike price of $42,000 for a premium of $500.
Simultaneously, the trader buys another BTC call with the same expiration and a strike price of $45,000 for $200. In this case, the net credit is $300 due to the difference between the $500 and $200 premiums.
The max gain from the above trade example is the credit the trader received (i.e., $300). For the trader to keep this $300, Bitcoin must stay below the break-even price by expiration, which traders calculate by adding the strike price for the short call with their credit (here, $42,000 + $300 = $42,300).
So if BTC stays below $42,300 at expiration, both options in the bear call spread expire worthless, and the trader realizes their maximum gain. Conversely, the trader will lose money if Bitcoin spikes above $42,300 on expiration day.
Since both options have fixed strike prices, the maximum losses are limited even if BTC continues rising to infinity. The most the trader will lose is the difference between the strike prices minus the premium [or ($45,000 - $42,000) - $300 = $2,700].
Benefits and drawbacks of using bear call spreads
Using bear call spreads is a popular strategy when the crypto market pulls back, but this derivatives technique has a few drawbacks. Traders must consider the pros and cons of using bear call spreads and whether they make the most sense versus other strategies and derivative products.
Pros of bear call spreads in crypto
Unlike other bearish strategies like shorting a cryptocurrency, bear call spreads don't have unlimited loss potential. Even if a digital currency skyrockets in value, the max losses from a bear call spread are pre-set and transparent, making it easy for traders to evaluate their risk-reward ratios.
Bear call spreads are a helpful tool to generate consistent returns when crypto assets are trending down or sideways. Whether crypto traders want to speculate on bearish price momentum or hedge long-term crypto positions, this options strategy offers a simple way to profit and protect capital during bearish periods.
Time is on a trader's side when they're in crypto bear call spreads. As long as the cryptocurrency stays below the break-even price, crypto traders gain a little each day as expiration draws near. Since this "time decay" works in a trader's favor, it's easier to close winning positions early at a discount to lock in gains and avoid the extra risk of waiting till expiration.
Options contracts give traders control over large crypto positions without risking significant capital. Instead of buying or shorting cryptocurrencies outright, traders only need to pay the premiums to enter and exit their positions, making crypto trading more accessible.
Cons of bear call spreads in crypto
Crypto traders who opt for bear call spreads rather than selling short trade off higher potential profits for extra security. Even if a cryptocurrency falls to zero, the maximum gain for a bear call spread is set at whatever premium they received to open the position.
Bear call spreads cost more in total fees since traders have to open two positions. In addition to commission fees, there are short-term capital gains tax implications for options trading, which eat into a trader's profit potential.
Unlike perpetual swap contracts, using options in bear call spreads is a time-sensitive strategy. These fixed expiration dates reduce flexibility and force traders to pay more in fees if they want to roll their positions for longer.
Exchanges typically offer two options styles: American and European. While there are other styles, these two are pretty common. In the American style, traders can exercise their contracts before the expiry date. In the European style, however, traders are allowed to exercise their contracts only at the expiration date of the option.
So if a trader’s exchange offers the American style and the short option in a bear call spread is in the money (ITM) before expiration, there's a chance a counterparty closes the trader’s position early and forces them to exit their bear call spread at a loss. Therefore, it’s recommended to double-check the rules on a crypto exchange beforehand to understand the risks of entering options positions.
Enhance crypto risk management with dYdX perps
Perpetual swaps are a hot derivative category often used to help protect crypto portfolios. Unlike crypto options contracts, perpetuals don't have expiry dates, giving traders the freedom to hold long or short positions indefinitely. dYdX's premier decentralized exchange provides eligible traders the tools they need to add Bitcoin and altcoin perps to their strategies. Check out dYdX's latest features, products, and services on our official blog. Also, head to dYdX Academy, our in-house resource library, for more helpful guides on crypto technology, derivatives, and trading tactics.
Start trading on dYdX today.
Disclosures
The content of this article (the “Article”) is provided for general informational purposes only. Reference to any specific strategy, technique, product, service, or entity does not constitute an endorsement or recommendation by dYdX Trading Inc., or any affiliate, agent, or representative thereof (“dYdX”). Use of strategies, techniques, products or services referenced in this Article may involve material risks, including the risk of financial losses arising from the volatility, operational loss, or nonconsensual liquidation of digital assets. The content of this Article does not constitute, and should not be considered, construed, or relied upon as, financial advice, legal advice, tax advice, investment advice, or advice of any other nature; and the content of this Article is not an offer, solicitation or call to action to make any investment, or purchase any crypto asset, of any kind. dYdX makes no representation, assurance or guarantee as to the accuracy, completeness, timeliness, suitability, or validity of any information in this Article or any third-party website that may be linked to it. You are solely responsible for conducting independent research, performing due diligence, and/or seeking advice from a professional advisor prior to taking any financial, tax, legal, or investment action.
You may only use the dYdX Services in compliance with the dYdX Terms of Use available here, including the geographic restrictions therein.
Any applicable sponsorship in connection with this Article will be disclosed, and any reference to a sponsor in this Article is for disclosure purposes, or informational in nature, and in any event is not a call to action to make an investment, acquire a service or product, or purchase crypto assets. This Article does not offer the purchase or sale of any financial instruments or related services.
By accessing this Article and taking any action in connection with the information contained in this Article, you agree that dYdX is not responsible, directly or indirectly, for any errors, omissions, or delays related to this Article, or any damage, injury, or loss incurred in connection with use of or reliance on the content of this Article, including any specific strategy, technique, product, service, or entity that may be referenced in the Article.