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Bull Call Spread - Introduction
There are quite a number of alternate ways to look at a Bull Call Spread. One of which is that this is a technique to buy call options at a discount. Because you sell to open an Out of the Money call option in this strategy, it effectively reduces your investment on your In the Money or At The Money call options. In this aspect, a Bull Call Spread is a way to buy call options at a cheaper price.
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.
Example : Assuming QQQQ at $44. Buy To Open 10 QQQQ Jan44Call, Sell To Open 10 QQQQ Jan45Call
If you expect QQQQ to go up to near $46 by expiration, you will Sell to Open QQQQ Jan46Call instead. |
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.
Profit Calculation of Bull Call Spread:
Maximum Return = (Difference in strikes - Net Debit) ÷ Net Debit
Following up from the above 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
Break Even = Lower Strike + Net Debit = $44 + $0.45 = $44.45 |
Risk / Reward of Bull Call Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
Net Debit Paid
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.
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.
Notes and references
- http://www.optiontradingpedia.com/free_bull_call_spread.htm
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