If you are interested in option trading, you might have heard of the Bull Call Spread Strategy. This is a type of options strategy that involves buying and selling call options on the same underlying asset with the same expiration date, but with different strike prices. The bull call spread strategy is used when you have a bullish outlook on the market, but you expect only a moderate rise in the price of the underlying asset. In this article, we will explain what is a bull call spread strategy, how it works, and what are its benefits and drawbacks. We will also provide an example and a pay-off diagram to illustrate the strategy.
What is Bull Call Spread Strategy?
A bull call spread strategy is a type of vertical spread, which means that it involves options with the same underlying asset and expiration date, but different strike prices. A bull call spread strategy consists of two legs:
- Buying a call option with a lower strike price, which is in-the-money (ITM) or at-the-money (ATM). This is the long call leg of the spread.
- Selling a call option with a higher strike price, which is out-of-the-money (OTM). This is the short call leg of the spread.
The goal of a bull call spread strategy is to profit from a moderate increase in the price of the underlying asset. If the price of the underlying asset rises moderately and is near or above the higher strike price at expiration, the strategy will reach its maximum profit. However, if the price falls or does not rise significantly, the strategy will incur a loss, which is limited to the net premium paid to establish the spread.
How does it work?
This strategy capitalizes on a bullish market outlook while reducing the overall cost of establishing the position compared to simply buying a call option outright. The basic mechanics involve:
Buying a lower strike call option: This allows you to profit from the upward movement of the underlying asset.
Selling a higher strike call option: This generates income to offset the cost of the purchased call option.
The goal is for the price of the underlying asset to increase, ideally surpassing both strike prices by the options’ expiration date.
Bull Call Spread Example
Let’s look at a bull call spread example to see how the strategy works in practice. Suppose you are bullish on SBI BANK, which is currently trading at ₹640 per share. You expect the stock to rise moderately in the next month, but not beyond ₹650. You decide to implement a bull call spread by buying a call option with a strike price of ₹640 and a premium of ₹3, and selling another call option with a strike price of ₹645 and a premium of ₹1. Both options expire in one month.
The net premium paid to establish the spread is ₹2 (₹3 – ₹1) per share. Since each option contract represents 1500 shares, the total cost of the spread is ₹3000 (₹2 x 1500). This is also the maximum loss that you can incur if the stock price falls below ₹638 at expiration.
The breakeven point of the spread is ₹642 (₹640 + ₹2). This means that you need the stock price to rise above ₹642 at expiration to make a profit.
The maximum profit of the spread is ₹3 (₹5 – ₹2) per share. Since each option contract represents 1500 shares, the total profit of the spread is ₹4500 (₹3 x 1500). This is also the maximum profit that you can make if the stock price rises above ₹645 at expiration.
Benefits of Bull Call Spread
The main benefits of a bull call spread strategy are:
- It reduces the cost of buying a call option, as the premium received from selling a call option offsets the premium paid for buying a call option.
- It reduces the risk of buying a call option, as the maximum loss is limited to the net premium paid, which is lower than the premium paid for buying a call option alone.
- It allows you to profit from a moderate rise in the price of the underlying asset, without exposing yourself to unlimited downside risk.
Drawbacks of Bull Call Spread
The main drawbacks of a bull call spread strategy are:
- It limits the profit potential of buying a call option, as the short call option caps the maximum profit at the difference between the two strike prices minus the net premium paid.
- It requires the price of the underlying asset to rise above the break-even point to make a profit, which is higher than the strike price of the long call option.
- It involves paying commissions and fees for both buying and selling call options, which can reduce the net profit or increase the net loss.
Conclusion
In conclusion, the Bull Call Spread Options Strategy presents an appealing balance between risk and reward for traders interested in leveraging a bullish market stance. Its structured approach and defined risk make it a valuable tool within the realm of option trading.
In Investar Software, you can view the charts of the bull call spread, and in addition also view the Option Chain and Option Greeks. Greeks like Delta, Gamma, and Theta can give you insights into how the option price will react to changes in the underlying stock price, time decay, and volatility. It will make your trading easier.
After installing the Investar Software, you will get many amazing features automatically.