The bull call spread option trading strategy is
employed when the options trader thinks that the price of the underlying asset
will go up moderately in the near term. Bull call spreads can be implemented by buying
an at-the-money call option while simultaneously
writing a higher striking out-of-the-money
call option of the same underlying
security and the same expiration month.
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Bull Call Spread Construction
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Buy 1 ITM Call
Sell 1 OTM Call |
By shorting the out-of-the-money call, the
options trader reduces the cost of establishing the bullish position but
forgoes the chance of making a large profit in the event that the underlying
asset price skyrockets. The bull call spread option strategy is also known as
the bull call debit spread as a debit is taken upon entering the trade.
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Bull Call Spread Payoff Diagram
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Limited Upside profits
Maximum gain is reached for the bull call spread
options strategy when the stock price move above the higher strike price of the
two calls and it is equal to the difference between the strike price of the two
call options minus the initial debit taken to enter the position.
The formula for calculating maximum profit is
given below:
- Max Profit
= Strike Price of Short Call - Strike Price of Long Call - Net Premium
Paid - Commissions Paid
- Max Profit
Achieved When Price of Underlying >= Strike Price of Short Call
Limited Downside
risk
The bull call spread strategy will result in a
loss if the stock price declines at expiration. Maximum loss cannot be more
than the initial debit taken to enter the spread position.
The formula for calculating maximum loss is
given below:
- Max Loss =
Net Premium Paid + Commissions Paid
- Max Loss
Occurs When Price of Underlying <= Strike Price of Long Call
Breakeven Point(s)
The underlier price at which break-even is
achieved for the bull call spread position can be calculated using the
following formula.
- Breakeven
Point = Strike Price of Long Call + Net Premium Paid
Bull Call Spread
Example
An options trader believes that XYZ stock
trading at Rs42 is going to rally soon and enters a bull call spread by buying
a JUL 40 call for Rs300 and writing a JUL 45 call for Rs100. The net investment
required to put on the spread is a debit of Rs200. The stock price of XYZ begins to rise and closes
at Rs46 on expiration date. Both options expire in-the-money with the JUL 40
call having an intrinsic value of Rs600 and the JUL 45 call having an
intrinsic value of Rs100. This means that the spread is now worth Rs500 at
expiration. Since the trader had a debit of Rs200 when he bought the spread,
his net profit is Rs300. If the price of XYZ had declined to Rs38
instead, both options expire worthless. The trader will lose his entire
investment of Rs200, which is also his maximum possible loss.
Disclosure/Disclaimer and FAQ
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