• Bear call spread is an option strategy used by traders to cap their maximum loss.
• At first, a trader is bearish with the downside capped, so he initiates a sell call option, i.e., the spot price is higher than the strike price.
• In a sell call option, maximum profit is fixed, which is equal to the premium received and the maximum loss is unlimited.
• If the price falls as he expects, the maximum profit will be the premium received.
• However, the trader later observes a support level at the bottom and expects the trend to be bullish.
• Suppose the trader’s worry became true and the price started to revert back from the support. The trader will fall into huge loss.
• To reduce his loss, he initiated a buy call option, such that the strike price of the buy call option is more than the strike price of the sell call option.
• In this case, the trader receives a higher premium for the sell call option than he pays to the buy call option.
• If the price falls, the trader would incur a profit in the sell call option but at the same time incur a loss in the buy call option.
• Since the gain is higher than the loss, the profit is now limited and it is equal to the difference between the premium received and the premium paid.
• If the price rises, the trader would incur a loss in the sell call option but at the same time incur a profit in the buy call option. Since the loss is higher than the gain, the loss is now limited.
• This way, the trader reduced his maximum loss, from unlimited to limited.

Consider an example: a trader initiated a bear call spread option strategy

Short Call: Strike Price = 1000 & Premium Received = 40

Long Call: Strike Price = 1050 & Premium Paid = 30

P/L = Profit/Loss

The graph clearly depicts the difference between a sell call option and a bear call spread option.

In the second strategy, the maximum loss is limited.