The bull call spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will go up moderately in the near term.Bull call spreads can be implemented by buying an at-the-money call option while simultaneously writing a higher striking out-of-the-money call option of the same underlying security and the same expiration month.
By shorting the out-of-the-money call, the options trader reduces the cost of establishing the bullish position but forgoes the chance of making a large profit in the event that the underlying asset price skyrockets. The bull call spread option strategy is also known as the bull call debit spread as a debit is taken upon entering the trade.
Limited Upside profits
Maximum gain is reached for the bull call spread options strategy when the stock price move above the higher strike price of the two calls and it is equal to the difference between the strike price of the two call options minus the initial debit taken to enter the position.
The formula for calculating maximum profit is given below:
Max Profit = Strike Price of Short Call – Strike Price of Long Call – Net Premium Paid – Commissions Paid
Max Profit Achieved When Price of Underlying >= Strike Price of Short Call
Limited Downside risk
The bull call spread strategy will result in a loss if the stock price declines at expiration. Maximum loss cannot be more than the initial debit taken to enter the spread position.
The formula for calculating maximum loss is given below:
Max Loss = Net Premium Paid + Commissions Paid
Max Loss Occurs When Price of Underlying <= Strike Price of Long Call
The underlier price at which break-even is achieved for the bull call spread position can be calculated using the following formula.
Breakeven Point = Strike Price of Long Call + Net Premium Paid
Bull Call Spread Example
An options trader believes that XYZ stock trading at $42 is going to rally soon and enters a bull call spread by buying a JUL 40 call for $300 and writing a JUL 45 call for $100. The net investment required to put on the spread is a debit of $200.
The stock price of XYZ begins to rise and closes at $46 on expiration date. Both options expire in-the-money with the JUL 40 call having an intrinsic value of $600 and the JUL 45 call having an intrinsic value of $100. This means that the spread is now worth $500 at expiration. Since the trader had a debit of $200 when he bought the spread, his net profit is $300.
If the price of XYZ had declined to $38 instead, both options expire worthless. The trader will lose his entire investment of $200, which is also his maximum possible loss.
Note: While we have covered the use of this strategy with reference to stock options, the bull call spread is equally applicable using ETF options, index options as well as options on futures.
For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).
Aggressive Bull Call Spread
One can enter a more aggressive bull spread position by widening the difference between the strike price of the two call options. However, this will also mean that the stock price must move upwards by a greater degree for the trader to realise the maximum profit.