Vertical spreads offer an option trader a wide variety of risk/reward scenarios. As I like to say about options, there are always tradeoffs. The various strategies that can be used and vertical spreads are no different.
 
Many new option traders tend to stay away from credit spreads. Debit spreads (depending on how they are implemented) usually offer higher rewards based on the risk amount and are often viewed as a “safer” choice and easier to understand. Once the credit spread is understood, many option traders prefer it over the debit spread. Let’s take a look at several bearish vertical spreads and some of the points option traders need to reference.

Benefits

One of the nice things about a credit spread is it can profit if the underlying doesn't move much or moves in the intended direction. A debit spread, such as a bear put spread, often needs the underlying to fall to profit.
 
A bear call spread involves selling a call option while purchasing a higher strike call option with the same expiration. The short call option is more expensive than the long call option. Adding a long call option to the short call position creates a credit spread and protects the position from further losses if the underlying rallies past the two strikes. This credit spread has a smaller potential profit than a naked call option but also limits risk. 

Here's an Example:

 First Solar Inc. (FSLR) was trading at around $69 earlier this month. After moving higher early in December, the stock has been trading sideways, unable to close above the $71 area.  A trader might assess that this resistance could be a difficult area for the stock to rise above even with this recent move lower. He or she could thus try to capitalize from this forecast by trading a bear call spread.
 
Here the trader would sell a call even a little higher than potential resistance at $71 and buy a higher-strike call for protection, thus creating the spread. 

Decisions

With a bear call spread, choosing strikes that are farther away from the current price with the same strike distance usually means less credit will be received on the spread. For example, if the current stock price is $69, a 72.5/77.5 bear call spread should generate a larger credit than a 75/80 bear call spread. The credit received is the maximum profit that can be attained. So, with a bear call spread, there exists a natural tradeoff of chances of success vs. payout structure. The higher the short strike, the safer; the lower, the greater profit potential.

How to Implement

In the above example, the trader decides to sell a 75/80 February (Feb 16th) bear call spread as follows: Sell the February 75 call for a credit of 1.60 and buy a February 80 call for a debit of 0.80. The total credit on the spread is 0.80. If FSLR finishes at or under $75 by February expiration, the spread would expire worthless and the trader would keep the credit. The maximum at risk on the trade is the difference in the strike prices minus the credit received, which in this case is 4.20 (5 – 0.80). The breakeven point is $75.80 (75 + 0.80), which is derived from adding the credit to the short call.

Final Word

When choosing whether to do a bear call or a bear put, a trader also has to take into account his or her trading personality. Just because one spread may seem advantageous over another doesn’t mean it should necessarily be implemented. Some option traders cannot bear the thought of taking a maximum loss on a credit spread like the bear call and have trouble sleeping at night worrying about it. But if that is not a major concern for you as a trader, remember depending on how it is implemented, a bear call spread may offer a lower profit potential but also provides more of a chance to profit.

John Kmiecik, Market Taker Mentoring