Bull Call Spread: Definition, How To Implement It?

What Is A Bull Call Spread?

A Bull Call Spread is an options trading strategy, that involves buying a call option at a specific strike price while selling a call option at a higher strike price simultaneously. Both the call options should be of a similar expiration date and underlying asset.

The Bull Call Spread is best performed when the investor’s outlook on the stock or other underlying asset is moderately bullish but not that aggressive.

Understanding The Bull Call Spread

As we know the spread strategies are some of the most uncomplicated options trading strategies that a trader can implement easily. Like every spread strategy, the Bull Call Spread is a multi-leg strategy involving 2 or more options. Multi-leg strategy means the strategy that requires 2 or more options contracts in the transactions.

The Call options are generally used by investors to get benefit from an upward movement of a stock’s price. The most important thing is that the options contract does not require the trader to buy the shares if they wish not to. Traders who think a particular stock or underlying asset is ready for an upside move then will use the call options.

In case of a fall in the stock price, the trader will lose the value of the premium during expiration. So, to counter that loss the trader should sell a call option at a higher strike price. If the stock price does not move above the strike price then the trader will receive the premium at which he sold the call option.

Building A Bull Call Spread

The bull call spread strategy decreases the cost of the call option, but the gains in the stock’s price are also limited with a small range where the investor can make a good profit. Most traders use the bull call spread if they think a stock will rise moderately. Mostly when there is high volatility in the market, they use this strategy.

Steps to build a Bull Call Spread:

  1. Choose a stock or index you believe will rise over some days, weeks, or months.
  2. Buy a call option of a higher strike price above the current stock price with a specific expiration date and pay the premium, also known as a long call.
  3. Concurrently, sell out of the money call option at a higher strike price than the previous call option, but the expiration date should be the same as the first call option, also known as a short call.
 

By selling a call option, the trader will receive a premium, which partly compensates the price they paid for the first call option. The net difference between the two calls is the cost of this strategy.

While investing in a bull call spread, the trader should not ignore the brokerage cost, he has to pay.

Maximum Profit

Potential maximum profit is restricted to the difference between the strike prices minus the net cost of the spread including brokerage.

Maximum Loss

The maximum loss is similar to the cost of the spread including the brokerage. A loss will occur if the position is held till expiration and both call options expire worthlessly. Both calls will expire worthless if the stock price at expiration ends up below the strike price of the long call.

Breakeven Point

The strike price of the long call option with the lower strike price plus the net premium paid.

Example

An options trader buys XYZ stock Oct call at the $100 strike price and pays $3 per options contract when XYZ is trading at $98 per share with a lot size of 100.

At the same time, the trader sells 1 Citi Oct call at the $110 strike price and receives $1.5 per options contract. Because the trader paid $3 and received $1.5, the trader’s net cost to create the spread is $1.5 per options contract or $150 if lot size equals 100. Means If the stock stays below $100 till expiry, both options will expire worthlessly, and the trader loses the premium paid of $150 or the net cost of $1.5 per options contract.

In scenario 2 if the stock increase to $112, the value of the $100 call would rise to $12, and the value of the $110 call would settle at $2 and the trader’s profit on the two call options would be $10 minus the cost of the spread $1.5 equals to $8.5 or $850 ($8.5×100). How ever, any further gain in the stock does not matter to the profit as the profit in this strategy is limited.

Limitations Of Bull Call Spread

The only limitation of the Bull Call Spread is the profits in this strategy is limited, any further gain in the stock will not benefit the trader. Another thing is that if your brokerage commission is too high then the profit will reduce significantly as the cost of spread will be too high. Consider a naked call option if you’re highly bullish on a stock and convinced that it will move significantly higher to get maximum profit at a very low cost.

Key Takeaways

  1. A Bull Call Spread is a fundamental spread that you can place when the viewpoint is moderately bullish.
  2. A moderate move in a stock/index would mean you anticipate a movement in the stock/index but the outlook is not that aggressive
  3. The normal bull call spread involves buying at the money option and selling out of the money option all belonging to the same expiry, same underlying, and equal quantity.
  4. The volatility plays an important role in the selection of the strike price.
  5. The risk-reward is also limited based on the strike price you choose.

Conclusion

The bull call spread strategy has some other names like long call spread, debit call spread, etc. The term bull attributes to the fact that the strategy profits with bullish, or rise in stock prices. This is one of the most famous options strategies widely popular among traders. Though the profit is limited the loss is also limited in this strategy and chances of gain are pretty much higher and the required investment is also quite lower compared to most multi-legged options strategies.

Source: ProjectOption

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