Turning Volatility into Opportunity
It’s remarkable how many traders, even seasoned professionals, shy away from challenging markets. Volatility, which unnerves so many, is precisely what makes options trading so powerful. Unlike traditional investments, options offer a suite of strategies to profit in any market—bullish, bearish, or flat.
In yesterday’s post, “War? UNH! What’s It Good For?”, Tim outlined a potential bearish setup in United Healthcare (UNH). Regardless of whether you’re bullish or bearish on the company, let’s explore an example of structured, high-probability approach to capitalize on a potential decline in UNH’s price: the bear call spread.
Why a Bear Call Spread?
A bear call spread (also called a short call vertical spread) allows traders to generate income in a bearish scenario while keeping risk defined. Here’s how it works:
- Sell a call option at a strike price above the current stock price.
- Buy a call option at a higher strike price to cap your risk.
The goal? Collect a premium and profit if the stock stays below your short call strike by expiration.
The Setup: UNH Bear Call Spread
UNH is currently trading around $543.59. For this trade, I’m using the March 7, 2025, expiration (38 days away) and aiming for an 80-85% probability of success. Why this probability? It strikes a balance between risk and reward while leveraging the edge offered by time decay.
Step 1: Choosing the Short Call Strike
To identify the short call strike, I look for an option with approximately 80% probability of expiring out of the money (OTM). For platforms that don’t show probabilities, the delta can serve as a proxy—look for deltas between 0.15 and 0.20.
For this trade:
- The 575 call strike has an 80.15% probability of success.
- Our chosen short call strike just outside the expected price range (+/- $29.13), providing a cushion.
Step 2: Selecting the Long Call Strike
Next, I pair the short call with a long call to create the spread. In this case, I’m using the 580 call strike, creating a 5-point-wide spread. This spread width defines the risk and reward:
- Net Credit (Premium Received): $0.90, or $90 per spread
- Maximum Risk: $4.10, or $410 per spread
- Maximum Return: 22.0% if the stock stays below $575 through expiration
The Mechanics of the Trade
Here’s the trade in action:
- Sell to open the March 7, 2025, 575 strike call.
- Buy to open the March 7, 2025, 580 strike call.
By collecting $0.90 in premium, you establish a position that benefits from time decay and a lack of upward momentum in UNH. As long as UNH remains below $575 at expiration, the trade achieves maximum profit.
Why This Works
The brilliance of a bear call spread lies in its flexibility and probabilities:
- Defined Risk: You know your exact risk ($410) and reward ($90) upfront.
- Time Decay Advantage: Options lose value as expiration approaches, and as the seller, this works in your favor.
- High Probability: With an 80% chance of success, the odds are stacked in your favor.
And even if UNH moves against you, as long as it stays below $575, you can still achieve max profit.
Risk Management: The Cornerstone of Success
No trade is complete without a plan to manage risk. Here’s how I approach it:
- Position Sizing: I allocate only 1-5% of my portfolio per trade, ensuring no single loss derails long-term performance.
- Profit-Taking: I rarely hold spreads to expiration. Instead, I aim to lock in 50-75% of the original premium. For this trade, I’d close the spread when its value drops to $0.45-$0.30.
- Stop-Losses: If the spread value doubles or triples (to $1.80-$2.70), I cut my losses and exit.
Key Takeaways
- Volatility Creates Opportunity: Markets don’t need to rise for you to profit. Strategies like bear call spreads thrive in uncertain or bearish conditions.
- Probabilities Over Predictions: By targeting an 80% probability of success, you focus on statistical edges rather than speculative guesses.
- Risk Management is Non-Negotiable: Knowing your risk before entering a trade—and sticking to it—separates successful traders from the rest.
Summary: The UNH Bear Call Spread
- Underlying Stock: United Healthcare (UNH)
- Current Price: $543.59
- Expiration Date: March 7, 2025 (38 days)
- Strategy: Bear Call Spread (Short Vertical Call Spread)
- Trade Details:
- Sell the 575 call
- Buy the 580 call
- Net Credit: $0.90, or $90 per spread
- Probability of Success: 80.15%
- Maximum Return: 22.0%
By leveraging defined-risk strategies like this, traders can navigate volatile markets with confidence. Whether UNH moves slightly up, trades sideways, or declines, this trade has a high probability of delivering returns—if managed correctly.
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