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What Are Options | The Bull Call Spread
Spreads | The Bull Call Spread
The bull call spread involves the purchase of a call option on a specific underlying security, while simultaneously selling or “writing” a call option on the same security with the same expiration date, but a higher strike price. This slightly advanced options and very popular technique is classified into a group of strategies known as vertical spreads. Vertical spreads are a family of spreads involving stock options with the same underlying security, the same expiration month, but different strike prices. Spreads can be created with either call options or put options and can be used to establish either a bullish or bearish position; thus they can be used by investors with different stock and market sentiment.
Before reading about the bull call spread options strategy, make sure your familiar with how call options work. The purchase of a call option is referred to as being long a call while selling a call option is known as being short a call.
The bull call spread is most useful when one has a moderately bullish outlook on a particular stock. If one holds a strongly bullish view on a stock he/she would be better off by employing the long call strategy since profits are limited from the bull call spread. The bull call spread is pertinent when an investor wants to capitalize on an small increase in the price of the underlying security.
Bull Call Spread Video Tutorial
The Bull Call Spread | Advantages and Disadvantages
The bull call spread is employed by purchasing an “at the money” call option on a specific security. This call option grants the buyer the right, but not the obligation, to purchase 100 shares of the underlying security at the strike price, prior to the expiration date. Simultaneous with the purchase of the call option, an “out of the money” call option is sold or “written”. While short this call option, the investor can be assigned to deliver 100 shares of the stock at the strike price should the price of the security rise above the strike price. The sale of the higher strike call serves to offset the cost of the call that is purchased, effectively reducing the price paid to buy the call. Also, the total risk involved is less than actually purchasing a call option alone, because the premium is reduced. Additionally, the long call purchased hedges the risk of the overall trade because if assigned to deliver the stock at the short call strike price the investor can exercise the lower strike call and purchase the stock at the lower strike price. Therefore, the bull call spread has three main advantages:
- Risk is limited to the overall price paid to place the trade: Max loss = Initial debit paid
- If the stock price fails to rise above the strike price of the short call, but is higher than the strike price of the long call, the profit is greater than simply buying the call alone
- Reduces the cost of purchasing call options
The main disadvantage of the bull call spread is that the potential for profit is limited. The gains are capped at the strike price of the short call. Also, as with the long call strategy, if the stock price falls the entire inital investment can be lost. Options can be risky as one can lose their entire initial investment and therefore investors must make sure then understand the inherent risks involved with buying call options. Therefore, the main disadvantages of the bull call spread are:
- Profit is limited: Max profit = Short call strike price - long call strike price - debit paid
- Single direction trade, profit is accrued only when stock price rises.
- Entire premium will be lost is the stock price falls below the strike of the purchased call option
Bull Call Spread Conclusions
Vertical spreads can be a good way to establish a cheap bet the the price of a specific stock will rise. The bull call spread is a limited profit, limited loss options strategy that can be utilized when an investor has a moderately bullish view on a specific stock. Trading stock options can be risky and one should never purchase call options with more than what he or she can afford to lose. However, when done correctly the bull call spread can allow an investor to establish a cheap long stock position and to profit from a rise in the security’s price.
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