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"Closing a Losing Bull Call Spread?"

Question By Alex

"Closing a Losing Bull Call Spread?"

Let's say I open a bull call spread by buying a $50 call for $3 and selling a $55 for $2. If the stock price falls to $45 for example, why can't I buy back the $55 call I sold for cheaper and make that profit? For example, if the $55 call is now worth $.50, why can't I buy it back and make $1.50 on that and then simply lose the net debit I paid for the spread?

Asked on 16 Dec 2010

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Answered by Mr. OppiE

Hi Alex,

First of all, you can close out either leg of a Bull Call Spread at anytime you want to and even transform it into other options strategies by taking away from or adding to the position at any time.

In order to understand your situation with the current bull call spread, we need to first ascertain its maximum potential loss. The maximum potential loss of a Bull Call Spread is the net debit paid, which in this case is $3 - $2 = $1. This means that the most you can lose in this position is $1 no matter how low the stock price goes to. Here's a table listing the price of each leg in your bull call spread at different stock prices.

Stock Price Long $50 Call Short $55 Call Overall Value Overall P/L
$51 (assumed) $3 $2 $1 0
$45 $0.50 $0.01 $0.49 -$0.51

As you can see from the table above, you can indeed buy to close your short $55 call options for almost its maximum worth of $2 as profit but you would already have lost $2.50 from your long $50 call options so you would still end up in a loss of about $0.51. However, the good news is, you would be able to salvage $0.49 from your total net debit of $1 (which is your maximum loss potential) instead of losing your whole net debit as you suggested in your question.

If this is what you intend to do, you need to simply Buy To Close your short $55 call options and Sell To Close your long $50 call options in that order. Yes, you can't sell to close your $50 call options first unless you have the margin to hold the short $55 call options as a naked call write position.

If there is still time to significant time to expiration and you think the stock can still get back up before expiration, you could even Buy To Close your short $55 call options and then continue to hold the long $50 call options in anticipation of a rebound. If it does even get back up to breakeven, you would have profited from the decay of the short $55 call options that you sold at $2 and bought back at $0.01.

In conclusion, You can do all the actions that you suggested in your question and still not lose your whole net debit. If you think there is still hope for the stock to rebound, you could transform the position into a long call option position by closing out the short leg only.

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