Im actually pretty solid on bull and bear spreads but want to confirm–
The bear spread w/ calls would be to buy the higher X call, sell lower…my Q is- does the ‘lower’ X call have to be BELOW the current market price (making it in the money)? Is there a rule w/ regards to bear & bull spreads as to if one of the options must be in the money & the other out?
No the lower strike doesnt have to be below or above market. If the lower strike is higher than market price, the payoff is considered high probability. Lots of option players use that type of trade. That means you risk a lot to “win” very little. Its negative skew. You win often but you eventually lose a big one.
if the higher strike is lower than the market, you have a low probability spread. You risk little to win a lot.
not really. I know many option traders that do that. Its like betting on the heavy favorite in sportsbook. You can bet on Federer over an unranked player. You bet $100 to win $15… and you win most the time,… until you lose! Its just a high probability play.
Its also part of the iron condor bet: Taking a bear spread well above market on both strikes and taking a bull spread well below the market on both strikes. The hope is both legs win and profit from time decay.
In any case, it still stands that the only two examples of bear spreads in the Level III curriculum each have a lower strike below the spot and a higher strike above the spot. I’d go with that on the exam. Similarly for a bull spread.