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A Bull Call Spread, also known as a call debit spread, is a bullish strategy involving two call option strike prices:
- Buy one at-the-money or out-of-the money call.
- Sell one call further away from the money than the call purchased.
A trader would use a Bull Call Spread in the following hypothetical situation:
- A trader is very bullish on a particular stock trading at $50.
- The trader is either risk-averse, wanting to know before hand their maximum loss or wants greater leverage than simply owning stock.
- The trader expects the stock to move above $52.92 but not higher than $55.00 in the next 30 days.
- Buy One Call – Sell One Call
- Risk Defined & Profit Defined
- Bull Call Spread requires Accurate Predictions
- Bull Call Spread Profit, Loss, & Breakeven
- Max Profit
- Partial Profit
- Partial Loss
- Complete Loss
- Bull Call Spread & Call Option Comparison
- Lower Cost, Lower Breakeven Price
- Realistic Expectations
Buy One Call – Sell One Call
Given those expectations, the trader selects the $52.50 call option strike price to buy which is trading for $0.60. For this example, the trader will buy only 1 option contract (Note: 1 contract is for 100 shares) so the total cost will be $60 ($0.60 x 100 shares/contract).
Also, the trader will sell the further out-of-the money call strike price at $55.00. By selling this call, the trader will receive $18 ($0.18 x 100 shares/contract). The net effect of this transaction is that the trader has paid out $42 ($60 paid – $18 received).
In this situation, the trader is bullish: for example, the price chart shows very bullish action (stock is moving upwards); the trader might have used other technical or fundamental reasons for being bullish on the stock.
Risk Defined & Profit Defined
When a Bull Call Spread is purchased, the trader instantly knows the maximum amount of money they can possibly lose and the maximum amount of money they can make.
The max loss is always the premium paid to own the option contract minus the premium received from the off-setting call option sold; in this example, $42 ($60 – $18).
Whether the stock falls to $5 or $50 a share, the call option holder will only lose the amount they paid for the option spread ($42). This is the risk-defined benefit often discussed about as a reason to trade options. Similarly, the Bull Call Spread is profit-defined as well.
The max the trader can make from this trade is $208. How this max profit is calculated is given in detail on the Bull Call Spread profit and loss graph on the next page.
Bull Call Spread requires Accurate Predictions
The important part about selecting an option strategy and option strike prices, is the trader's exact expectations for the future. If the trader expects the stock to move higher, but only $1 higher, then buying the $52.50/$55.00 Bull Call Spread would be foolish. This is because at expiration, if the stock price is anywhere below $52.50, whether it be $20 or $52.49, the spread strategy will expire worthless.
Therefore, if a trader was correct on their prediction that the stock would move higher by $1, they would still have lost.
Moreover, if the trader is exceptionally bullish and thinks the stock will move up to $60, then the trader should just buy a call rather than purchase a Bull Call Spread.
In this example, the trader would not gain anymore profit once the stock moved past $55. This is explained on the next page.
Bull Call Spread Profit, Loss, & Breakeven
The following is the profit/loss graph at expiration for the Bull Call Spread in the example given on the previous page.
The breakeven point for the bull call spread is given next:
- Breakeven Stock Price = Purchased Call Option Strike Price + Net Premium Paid (Premium Paid – Premium Sold).
To illustrate, the trader purchased the $52.50 strike price call option for $0.60, but also sold the $55.00 strike price for $0.18, for a net premium paid of $0.42. The strike price paid was the $52.50.
Therefore, $52.50 + $0.42 = $52.92. The trader will breakeven, excluding commissions/slippage, if the stock reaches $52.92 by expiration.
The max profit for a bull call spread is as follows:
- Bull Call Spread Max Profit = Difference between call option strike price sold and call option strike price purchased – Premium Paid for bull call spread.
To illustrate, the call option strike price sold is $55.00 and the call option strike price purchased is $52.50; therefore, the difference is $250 [($55.00 – $52.50) x 100 shares/contract].
The net premium paid for the bull call spread is $42. Consequently, the max profit is $208 ($250 – $42).
As a sidenote, this max profit occurs when the stock price is at $55.00 (the upper call strike price) or higher at expiration.
Partial profit is calculated via the following, assuming the stock price is greater than the breakeven price:
- Bull Call Spread Partial Profit = Stock price – Breakeven price
For instance, the stock closed at $54.00 at expiration. Hence, the stock price at expiration ($54.00) minus the breakeven stock price ($52.92) would mean the trader profited $108 [($54 – $52.92) x 100 shares/contract]
A partial loss occurs between the lower purchased call strike price and the breakeven stock price. The calculation is given next:
- Bull Call Spread Partial Loss = Breakeven price – Stock price
For example, a closing stock price at expiration of $52.75 is between the lower strike price of $52.00 and the breakeven of $52.92 and is therefore going to be a partial loss. When calculated, the loss is $17 [($52.92 – $52.75) x 100 shares/contract]
A complete loss occurs anywhere below the lower purchased call strike price ($52.50) which amounts to the entire premium paid of $42.
Bull Call Spread & Call Option Comparison
The Bull Call Spread is liked by many traders more than simply buying a call option for two main reasons:
- Reduces the capital spent/lower breakeven price.
- Is a strategy than incorporates reality.
Lower Cost, Lower Breakeven Price
Because a bull call spread involves the selling of an option, the money required for the strategy is less than buying a call option outright. Moreover, the breakeven price is lowered when implementing a bull call spread.
To illustrate the cash outlay and breakeven prices for a bull call spread and just a call option are given next:
- Bull Call Spread: cost $42; breakeven price $52.92
- Call Option: cost $60; breakeven price $53.10
In percentage terms, the bull call spread is 30% cheaper than purchasing only the call option.
The second advantage/disadvantage of a bull call spread is that this strategy considers the reality and probabilities of a potential move. Theoretically, buying a call strategy has unlimited profit potential.
However, successful option traders generally focus on probabilities and take into consideration reality. A stock move from $50 to $55 is a 10% move. This has to occur in the time before expiration, in the example 30 days.
In order for a rational options trader to buy just a call, the option trader has to expect a stock move greater than 10% within 30 days.
In conclusion, the bull call spread is a great alternative to simply buying a call outright: the bull call spread reduces the breakeven price and decreases the capital required to be bullish on a stock, it also is a strategy that takes into consideration realistic expectations.