Why I Prefer the Bull Call Spread Instead of Covered Call

[ntrader 10]

Most of the times I prefer to open a bull call spread rather than writing a covered call for the same profit using less capital. Instead of buying the underlying stock in the covered call strategy, in the bull call spread strategy I have to buy deep-in-the-money call options. It is better for me to sell near-month options as time decay is at its greatest for these options. So the two strategies that I am comparing will involve selling near-month slightly out-of-the-money call options.

For example let’s say that the stock ABC currently trading at $100 in June and the July 110 call is priced at $4 while a July 90 call is priced at $11.50.

If you enter into a covered call write you have to buy 100 shares of ABC at $100 each and sell a July 110 call. The initial investment is $10000 (long stock) - $400 (short call) = $9600.

If you enter a bull call spread you can buy the July 90 call while selling the July 110 call. The initial investment in this case is $1150 (long call) - $400 (short call) = $750.

 

Profit/loss at various ABC stock price on expiration date.

 

Strategy Initial Investment Stock Price on Expiration

Below $90 $90 $100 $110 & Above

Bull Call Spread 750 -750 -750 250 1250

Covered Call 9600 Unlimited -300 200 1400

 

The maximum potential profit for the bull call spread is only $150 below than the covered call but the covered call has a potentially unlimited downside risk (all the initial investment $9600 in potential losses). So the bull call spread is a superior strategy to the covered call if you are willing to sacrifice some profits in return for higher leverage and significantly greater downside risk.

[JasonW 10]

Good point ntrader. In fact the bull call spread with a deep ITM long and a slightly OTM short is quite covered-call like, but with fewer resources tied up.

 

From my perspective the downside is the relative lack of positive theta caused by the long call. One reason why I've generally just kept with covered calls.

 

But I'd like to experiment with a deep ITM call on the long side that is out an additional week. So this would significantly reduce the loss to theta especially near expiration. Ideally both the long and short sides would be rolled to the next week on Thursday when the new options come out. Of course the long side will be rolled out to a point 7 days behind the short call. Also any adjustments to the strike could be made here.

 

So this is basically a bull call spread with a slight 'calendrical' element thrown in to improve positive theta.

 

The advantage over a pure calendar spread (long call distant expiration, short call close expiration, same strike) is that the risk to capital from premature exercise is reduced since (a) the expiration time differential is reduced and (b) the long call is deep ITM which has less time value.

[ntrader 10]

Thank you for your reply JasonW

 

For the bull call spread options strategy maximum gain is reached when the price of the underlying asset moves above the higher strike price of the two calls and it is equal to the difference between the strike prices of the two call options minus the initial debit taken to enter the position.

Bull call spread maximum profit: Strike price of short call – strike price of long call – net premium paid – commissions

[ntrader 10]

An alternative to the bull call spread is the Bull Put Spread.

Bull Put Spread is a bullish option strategy that works like a Bull Call Spread does, profiting when the underlying stock rises. Bull Put Spread is just a naked Put write which minimizes margin requirement and limits potential loss by purchasing a lower strike price put option.

Entering a Bull Put Spread involves the purchase of an Out of The Money put option while simultaneously writing an In the Money or At The Money put option on the same underlying asset with the same expiration.

[Larry1234 10]

Comparing Bull call spread vs Covered Call Strategy -

 

Adding to your point, I would like to say that you are assuming that there are no dividends and most importantly, traders generally prefer bull call spread instead of covered call because of lower investment.

 

Both the strategies can be used when the traders / investors are moderately bullish.

 

Break even point is -

 

For Bull Call Spread - (90 + 7.50) = $ 97.50

 

For Covered Call Strategy - $ 96

 

At the expiration, if the stock price decrease below the above level, then the traders will start making losses.

 

We should also consider break even price while entering the contract.

[ntrader 10]

One assumption is that there are no dividends and you are right that most traders in general prefer bull call spread instead of covered call and of course the traders should take consideration the breakeven point but also the volatility of the stock

[Larry1234 10]

One assumption is that there are no dividends and you are right that most traders in general prefer bull call spread instead of covered call and of course the traders should take consideration the break even point but also the volatility of the stock

 

When you talk about volatility of the option contract, it is measured by Vega which is one of the Option Greeks. Option Greeks plays an important role in determining the theoretical price of the option and the changes in option price w.r.t changes in prices of Underlying Assets, Time to expiration, Risk free rate (interest rate) and Volatility of the stock.

[ntrader 10]

Talking about volatility, the vega of an option expresses the change in the price of the option for every 1% change in underlying volatility. For example, if the theoretical price is 2.5 and the Vega is showing 0.25, then if the volatility moves from 20% to 21% the theoretical price will increase to 2.75. Vega is most sensitive when the option is at-the-money. Vega does not have any effect on the intrinsic value of options; it only affects the “time value” of an option’s price.