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Bull Call Spread - Definition
A bullish options strategy which aims to reduce the upfront cost of buying call options in order to profit from stocks that are expected to
rise moderately.
Bull Call Spread - Introduction
A Bull Call Spread is a bullish option strategy that profits if the underlying asset rises in price.
The Bull Call Spread's main advantage is that it is
cheaper than just buying call options. In fact, it is better known as an options trading strategy to buy call options at a discount.
The main drawback of the Bull Call Spread is that it has a limited profit potential. Other than that, the Bull Call Spread remains one
of the most commonly used options trading strategy of all time. This Bull Call Spread tutorial shall cover the bull call spread's logic,
when to use, how to use and different variants of the Bull Call Spread.
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Bull Call Spread - Classification
Type of Strategy : Bullish
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Type of Spread : Vertical Spread
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Debit or Credit : Debit
Bull Call Spread - Buying Call Options At A Discount
Time decay of
Extrinsic Value is the number one enemy of options traders buying
call options. Having the value of those call options decrease
each day the underlying stock fails to rise is certainly a painful ordeal. The Bull Call Spread helps to reduce the effects of time decay of
those call options by Selling to Open (shorting)
out of the money call options
in order to partially offset the price of these call options. This reduces the effect of time decay on the position and also increases
return on investment since part of the price of the call options have been offset by the sale of the out of the money call options. This effectively
allows you to buy call options at a discount and is what makes the Bull Call Spread so popular in options trading. Another beauty of the Bull Call Spread is that because it is cheaper than just buying call options, the resultant return on investment would also be higher when the underlying stock closes at the strike price of the short call options.
When To Use Bull Call Spread?
One should use a bull call spread when one is confident in a moderate rise in the underlying instrument.
How To Use Bull Call Spread?
Establishing a Bull Call Spread involves the purchase of an At The Money or In The Money call option on the underlying asset while simultaneously writing (sell to open) an
Out of the Money call option on the same underlying asset with the same expiration month.
Buy ATM Call + Sell OTM Call
Bull Call Spread Example :
Assuming QQQQ at $44. Buy To Open 10 QQQQ Jan44Call for $1.05, Sell To Open 10 QQQQ Jan45Call for $0.50.
Net Debit = $1.05 - $0.50 = $0.55
If you expect QQQQ to go up to near $46 by expiration, you will Sell to Open QQQQ Jan46Call instead.
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OTM Bull Call Spread
The Out of the Money Bull Call Spread is an extremely popular variant of the bull call spread used mostly by institutional speculators to speculate in explosive moves on the underlying stock using very little money. An OTM Bull Call Spread involves buying out of the money call options and then writing further out of the money call options against it.
Buy OTM Call + Sell Further OTM Call
Out of the Money Bull Call Spread Example :
Assuming QQQQ at $44. Buy To Open 10 QQQQ Jan46Call for $0.30, Sell To Open 10 QQQQ Jan47Call for $0.10.
Net debit = $0.30 - $0.10 = $0.20
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The Out of the Money Bull Call Spread is a speculative position that can be put on very cheaply. It makes a profit only when the underlying stock rallies beyond the strike price of the long call options and reaches it's maximum profit potential when it equals or exceeds the strike price of the short call options. If the underlying stock do stage such an explosive rally, the return on investment using the out of the money Bull call spread would be much higher than the conventional bull call spread outlined above. However, the risks are significant as well. If the stock rallies but fails to exceed the strike price of the out of the money long call options, the whole position expires worthless. Such trade-off between ROI and risk is prevalent in all options trading strategies.
Read the full tutorial on Out Of The Money Bull Call Spread.
Profit Potential of Bull Call Spread :
A Bull Call Spread profits if the stock goes up. When the stock goes up, the long call option profits while the
short call option
continue to decay in premium until it's strike price has been reached. From that point onwards, every move in the long call option is matched by an equal
move in the short call option, resulting in no further profits.
The maximum profit potential of a bull call spread is therefore when the price of the underlying asset rises up to the strike price of the out
of the money short call options and beyond.
The profitability of a bull call spread can also be enhanced or better guaranteed by legging into the position properly.
Profit Calculation of Bull Call Spread:
Maximum Return = (Difference in strikes - Net Debit) ÷ Net Debit
Following up from the above Bull Call Spread example:
Buy to open 10 QQQQ Jan44call for $1.05 per contract and sell to open 10 QQQQ Jan45call for $0.60 per contract
Max. Return = (45 - 44 - (1.05 - 0.60)) ÷ (1.05 - 0.60) = 0.55 ÷ 0.45 = 122%
Max. Risk = Net Debit = $1.05 - $0.60 = $0.45, if QQQQ is < $44
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Risk / Reward of Bull Call Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
Net Debit Paid
Break Even Point of Bull Call Spread:
BEP: Strike Price of Long Call Option + Net Debit Paid
Breakeven point of Bull Call Spread:
Buy to open 10 QQQQ Jan44call for $1.05 per contract and sell to open 10 QQQQ Jan45call for $0.60 per contract
Break Even = Lower Strike + Net Debit = $44 + $0.45 = $44.45
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Advantages Of Bull Call Spread :
Loss is limited if the underlying financial instrument falls instead of rise.
If the underlying instrument fails to rise beyond the strike price of the out of the money short call option, the profit yield will be
greater than just buying call options.
It is also a way of buying call options at a discount by selling the out of the money call option at a strike price beyond that which
the underlying instrument is expected to rise.
ROI is higher than just buying call options when stock closes at strike price of short call options.
Disadvantages Of Bull Call Spread :
There will be more commissions involved than simply buying call options.
There will be no more profits possible if the underlying instrument or stock rises beyond the strike price of the out of the money call option.
Alternate Actions Before Expiration :
1. If the underlying instrument or stock is expected to continue to rise strongly beyond the strike price of the short call option,
one could buy to close the out of the money short call option and then sell to open a further out of the money call option in its place.
2. If the underlying instrument or stock is expected to continue to rise strongly beyond the strike price of the short call option,
one could also choose to buy to close the out of the money short call option and then simply allow the long call option to continue to gain in value.
Bull Call Spread Questions:
Bull Call Spread on AAPL?
How Do I Close Out a Bull Call Spread?
What To Do When One Leg of Bull Call Spread Is Assigned?
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