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"What To Do With Profitable Bull Call Spread?"

Question By Ray Bidwell

"What To Do With Profitable Bull Call Spread?"

I have bought a bull call spread of 5 contracts of $129 and $132 Nov 20 expiry. Stock is now 134. What are the options, eg, do I buy and sell the underlying stock to trigger my 3 x 500 profit. How do the commissions work? Does the one bought call cancel out the sold call? Not a lot of info regarding the actual brokerage workings in options, it is all about which stocks and the types of option strategies. Thank you

Asked on 31 Oct 2010

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Answered by Mr. OppiE

Hi Ray,

First of all, congratulations on a profitable Bull Call Spread trade.

So, there is still time to expiration, the stock is already way above the strike price of the short call options and you are already in profit, what should you do?

In order to decide what to do, you need to first ascertain the maximum possible profit of your bull call spread. The Maximum Profit of a bull call spread is the difference between the strike prices less the net debit paid.

Assuming you bought the $129 strike price call options at $2.50 and wrote the $132 strike price call options at $1.00. Your net debit will be $2.50 - $1.00 = $1.50 and its maximum possible profit would be ($132 - $129) - $1.50 = $1.50.

At this point, since there are still some extrinsic value remaining in the position, you are unlikely to be at the maximum profit of $1.50 but if you are close enough to $1.50 and deem that there are significant risk that the stock might turn downwards before expiration, you might want to close the position and take profit.

In order to close out the bull call spread position, you do not need to exercise any of the options in the position. All you have to do is to BUY TO CLOSE the short $132 call options and the SELL TO CLOSE the long $129 call options in that sequence. If you attempt to sell to close the long $129 call options first, you will be prompted for margin as you would be left with a naked short call position after the sale. As such, you need to close the short $132 call options before closing the long $129 call options.

If for some reason your bull call spread position is still far from reaching its maximum profit potential and you do not see the stock coming back down lower than $132 by expiration, you could choose to hold on to the position till expiration. As long as the stock remains above $132 by expiration, your bull call spread position would still yield the same maximum profit and all you have to do is close out the position as described above. Again, there is no need to exercise or buy the stock in order to close the position.

In conclusion, Bull Call Spreads achieve their maximum profit potential when the stock exceeds the strike price of the short call options. If it is already near its maximum profit potential, there is little sense to hold on to it, taking the risk of the stock turning downwards. You would of course pay commission for each trade made closing the position, which is once for each leg.

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