Bull Call Spread

[Igor 10]

Traders who use a bull call spread strategy are betting that the market price of the underlying asset will go up moderately or substantially. The strategy involves buying a call option, and hedging it, by selling the same quantity of call options. A bull call spread strategy limits the investment's potential profit, but it also lowers the trader's exposure. Investors can trade options at a discount when using this strategy. It requires less cash to get into the market, which may help investors when trading options that they are less familiar with.

 

How to Enter a Bull Call Spread

A trader must perform two operations at the same time to enter a bull call spread.

First, a trader will need to buy a call that's In-The-Money (ITM).

Example: XYZ is trading at $42 (market price)

 

 

Buying a Call

1) Call Option Available: XYZJan40 ($3) - ITM

- One Option = 100 shares of XYZ stock

- Strike Price $40/per share, expiring on 1/15

- Premium Cost of $3.

2) Trader buys one call option and pays $300 [100 x $3 (premium cost)].

 

Selling a Call

Next, the trader will sell the same quantity of options that's Out-of-The Money (OTM).

1) Trader writes (sells): XYZJan45 ($1)

- One Option = 100 shares of XYZ stock

- Strike Price $45/per share, expiring on 1/15

- Premium Cost of $1.

2) Trader sells one call option and receives $100 [100 x $1 (premium cost)].

 

Result: The trader is in the options market for $200 (Amount Paid $300-$100 Amount Received).

 

Advantage and Disadvantage of Bull Call Spread

 

Pluses: The upside to this type of strategy is that the investor gets into the options market at a discount. Instead of paying the full price for a call, he or she can get a $100 discount from the short sale. This is also good for investors who prefer to watch the movement of an unfamiliar option. The investor is also controlling their losses. The most that a trader can lose in the example above is what he or she paid to enter the market, which is $200.

 

Minuses: The downside in using a bull call spread is that it limits an investor's profit. Even if the price of the call option in the above example soars, the investor will only receive a fixed profit, which depends on the strike price of the call and buy orders.

 

Examples Using the Buy and Sell Orders Above:

 

XYZ Market price declines to $38.

Result: Both the buy and sell call orders will expire OTM and worthless. The investor will receive no profit from the investment, and his or her total loss is $200, what was paid to enter the market.

 

XYZ Market price increases to $46.

Buy Order Result: The option expires ITM. The trader exercises his or her right to buy 100 shares at $40, and pays $4000 to whoever wrote the option.

Sell Order Result: The option expires ITM. The trader sells the 100 shares to cover the call, and receives $4500 from the buyer.

Total result: Trader receives $4500 (from sale) - Pays $4000(from buy) - $200 (to enter market) = $300 profit.

 

Choosing the Correct Strike Price

Looking at the example above, one can see that the strike price plays a significant role in profiting from a bull call spread. Choosing strike prices farther away from market prices can produce larger profits for investors, but they also take on more risk, since the option may not expire ITM when it expires.

[bobcollett 10]

Hi Igor

An interesting post

I just wonder if the risk:reward is right.

All this work for $300 against a possible $200 loss.

I realise its just an example and you could make much more , and you cant loose more than $200.

Why not buy the share and set a $200 stop loss.?

Save a lot of work for the same result.

Well we all have our different methods to make our daily bread.

kind regards

bobc