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"Strategies for ITM Bull Call Spread With Time To Expiration?"

Question By Floyd Back

"Strategies for ITM Bull Call Spread With Time To Expiration?"

What is the best, or is there more than one strategy when both calls of a bull call spread are in the money, but there is a long way to go until the expiration date?

Asked on 28 October 2013

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Answered by Mr. OppiE

Hi Floyd Back,

I assume what happened is that you went long a bull call spread with significant time to expiration, expecting the underlying stock to rally by expiration but that rally happened way too early and you are now holding a profitable bull call spread which is now in the money with significant amount of time left to expiration at or near its maximum profit potential.

The obvious answer to this is, of course, to just close the whole position using Sell To Close on the long leg and Buy To Close on the short leg in order to take profit. However, what if you think the stock could still move significantly to upside following this rally?

If you expect the stock to continue to rally further, there are three simple things you can do. First of all, if you expect the underlying stock to rally strongly from here onwards without a clear target price ceiling, what you could do is simply Buy To Close the short leg and continue to hold on to the long leg for unlimited profit. This is actually a very common scenario that bull call spread users find themselves in; What they think is going to be just a moderate rally turns into a strong sustained one.

If you expect the stock to continue to rally a little bit more, you can actually roll up the in the money short leg to the new out of the money strike price that you expect the underlying stock to rally to. This makes the position a new bull call spread with limit at the new out of the money strike price, effectively acting as partial hedge in case the price of the stock actually turns downwards and also increase profit should the price of the underlying stock reaches the predicted strike price.

Rolling Up The Short Leg

Assuming you were holding one contract of bull call spread on AAPL's January $190 and $210 call options when AAPL was trading at $190. The Jan190Call was asking at $13 and its Jan210Call was bidding at $6. Net debit for the position was $13 - $6 = $7, max profit potential = $210 - $190 = $20 - $7 = $13.

Assuming AAPL rallies to $250

Your Jan190Call is now worth $62 and the Jan210Call $50, net profit = $62 - $50 = $12. The position is now extremely close to its max profit potential with lots of time left to expiration. You are now of the opinion that AAPL is going to rally to $300 by expiration and you wish to extend your profit and partially hedge the position by Buying To Close the Jan210Call at $50 and then Sell To Open the Jan300Call which is now asking at $5.

Assuming AAPL rallies to $300 by expiration

Your Jan190Call is now worth $110 and the Jan300Call expires worthless. Total profit = ($110 - $13) + $5 - ($50 - $6) = $58


If you are of the opinion that the underlying stock is going to continue to rally a little bit more, you wish to profit from that move but you also want to be able to protect your current gains more. What you can do is do the above by rolling up the short leg and then use the cash gained from the sale of the new short leg towards the purchase of put options of the same price, forming what is known as a "Collar". The put options will then be bought at no additional cost but will act as a stop plug to prevent any lose of value below its strike price while keeping the upside for the long call options all the way up to the strike price of the new short call options.

Forming a Collar

Assuming you are holding one contract of bull call spread on AAPL's January $190 and $210 call options when AAPL was trading at $190. The Jan190Call was asking at $13 and its Jan210Call was bidding at $6. Net debit for the position was $13 - $6 = $7, max profit potential = $210 - $190 = $20 - $7 = $13.

Assuming AAPL rallies to $250

Your Jan190Call is now worth $62 and the Jan210Call $50, net profit = $62 - $50 = $12. The position is now extremely close to its max profit potential with lots of time left to expiration. You are now of the opinion that AAPL is going to rally to $300 by expiration and you wish to extend your profit and hedge the position by Buying To Close the Jan210Call at $50, Sell To Open the Jan300Call which is now asking at $5 and then buying the Jan210Put which is now asking for $5. In this case, the put options will completely prevent any lost of value should the price of AAPL fall below $210, thereby preserving a much bigger portion of the profits than just writing new out of the money call options can. However, this also means slightly lesser profit if AAPL reaches $300 by expiration as you would not profit from the sale of the new out of the money call options (due to using those proceeds towards the purchase of the put options as insurance).

Assuming AAPL rallies to $300 by expiration

Your Jan190Call is now worth $110 and the Jan300Call expires worthless. Total profit = ($110 - $13) - ($50 - $6) = $53





In conclusion, what follow up action to take depends really on what you expect the underlying stock to do and also your personal risk appetite, how much profit you are willing to risk for more potential upside and how confident you are on that outlook.

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