Options may also offer a better return on investment (ROI) compared to placing outright long or short bets using underlying stocks or derivatives.
As the name suggests, bull call spreads can be used when an investor is bullish on the market and wants to potentially profit from higher prices.
Bull Call Spread Strategy Explained
This strategy offers limited risk/limited profit trading with two options, long call and short call.
A long option is to buy close to “the money”, the current market price of the underlying asset. Short options are sold at a higher price or even “out of the money”.
The maximum profit potential of a trade can be easily calculated. To determine the maximum profit potential, take the difference in strike price, subtract the premium paid for the spread, and also factor in fees and commissions.
The maximum loss probability is even easier to calculate. The maximum amount of capital that can be lost is the premium paid on the spread plus the commission or fees.
Example: You are bullish on XYV stock, which is currently trading at $40 per share. You believe that stock prices are likely to rise in the next 30-60 days and would like to take a bullish position in stocks. Instead of buying 100 shares of XYZ and hoping the price will go up, you decide to start your call spread by buying a $40 call and selling a $44 call at a net premium of $1.00. The option expires in 60 days.
If the price of XYZ rises to $45 at expiration, the bullish call spread reaches its intrinsic value of $4.00 (calculated as the difference between the two strike prices of $40 and $44). Since you paid $1.00 for the spread, your net profit is $3.00.
Now suppose your prediction about the stock price is wrong and the stock price drops to the $38 level at maturity. In this case, both options expire worthless and the loss is equal to the maximum premium of $1.00 paid.
In another scenario, the stock price rises and is trading at $42 per share at expiry. In this case profit cold is calculated as the net profit of $1.00 by subtracting the premium paid ($1.00) from the intrinsic value of the spread ($2.00).
The break-even point for a bull call spread is calculated as the strike price of the long call minus the premium paid. So, using the example above, the break-even point is calculated as $41 ($40 long call strike plus $1.00 premium paid).
Bull Call Spread Payoff Diagram
when to wear
A bull call spree can occur at different times based on the trader’s goals, risk tolerance, and market conditions. However, there are some simple rules of thumb to consider. Since the spread is bullish, it is important to open the spread when the price is likely to continue rising or make a bullish reversal.
Markets that have recently hit new all-time highs with strong volumes can be good candidates for call spreads. Such market movements may allow traders to take advantage of an extension of the uptrend or a resumption of the uptrend.
Another good place to start the call spread is if the market falls to previous support levels or retreats within a larger uptrend. Bargain hunters may intervene in a market that has been beaten down to levels where buyers were previously found, prompting a reversal to the upside.
For markets that have been trending up on longer timeframes, a pullback to the support level could present an opportunity to go long the market before it moves back up again.
Pros of Bull Call Spread Strategy
Bull call spreads have several advantages. Perhaps the biggest advantage is the clear risk of positions. No matter what happens, traders will never lose more than the premium they paid.
Another big advantage is the high return on investment. The cost of a bull call spread can be quite low compared to the cost of holding a full long position in a stock or contract.
Cons of the Bull Call Spread Strategy
There is no free lunch when it comes to options trading, and bull call spreads are no exception. Spreads also have some drawbacks that should be considered carefully. The biggest drawback of bull call spreads is the effect of time decay, one of the option Greeks known as “theta” in the options world.
Since the option has an expiration date, it loses value over time while all other inputs remain constant. In other words, the timing has to be right as well as the direction of the market.
If both options are in-the-money, the theta of the bull call spread is positive. While this increases the odds of success, it also reduces the profit potential due to the higher cost of the ITM spread.
Bull call spreads can also require significant market movements to turn a profit. For this reason, it may be best to consider using the bull call spread only when you anticipate a significant move.
Managing the bull call spread is fairly easy. How you manage risk is a matter of taste. One simple way to manage risk is to determine exit points for closing positions. For example, if you paid a premium of $1.00 for a bull call spread, you could simply exit the spread if the price drops to $0.50.
This method is simple, but very effective, especially when the spread’s potential profit is more than four times the risk.
You can also adjust the bull call spread along the way. One adjustment is to buy back the short leg of the spread if the market is moving in your favor. This increases the capital risk of trading, but the total risk is still defined. However, buying back the short leg turns it into a position with infinite profit potential.
Other adjustments can also be made for spreads that are not progressing as planned. Selling the spread back to the market and buying the same spread at a further maturity is one such method.
The bull call spread is a versatile position with limited risk that even novice traders can take advantage of. Spreads can offer great profit potential with little stress. With its many benefits, bull call spreads should be part of every trader’s arsenal.
The bull call spread is a good options strategy for taking positions with limited risk and moderate upside. In most cases, traders may prefer to close an option position to make a profit (or mitigate a loss) rather than exercising the option to close the position due to significantly higher fees.
It also offers great flexibility when it comes to strike selection and expiration.
About the Author: Chris Young has a degree in Mathematics and 18 years of experience in finance. Chris is from the UK, but he has worked in the US and most recently in Australia. His interest in options was first aroused by the “Trading Options” section of the Financial Times (London). Determined to bring this knowledge to more people, in 2012 he founded Epsilon Options.
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