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    Bull Call Spread

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    pkkothari
    This strategy involves buying one call option and selling another call option at a higher strike price to help pay for the cost of the long call. If the stock price increases but stays below the higher strike price, the spread profits similar to a regular long call. However, if the stock rises above the higher strike price, gains are capped. The maximum profit is limited and defined as the difference between the strike prices minus the debit paid. The maximum loss is limited to the initial debit paid.

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    Bull Call Spread

    Uploaded by

    pkkothari
    230 views3 pages
    This strategy involves buying one call option and selling another call option at a higher strike price to help pay for the cost of the long call. If the stock price increases but stays below the higher strike price, the spread profits similar to a regular long call. However, if the stock rises above the higher strike price, gains are capped. The maximum profit is limited and defined as the difference between the strike prices minus the debit paid. The maximum loss is limited to the initial debit paid.

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    Bull Call Spread

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    This strategy involves buying one call option and selling another call option at a higher strike price to help pay for the cost of the long call. If the stock price increases but stays below the higher strike price, the spread profits similar to a regular long call. However, if the stock rises above the higher strike price, gains are capped. The maximum profit is limited and defined as the difference between the strike prices minus the debit paid. The maximum loss is limited to the initial debit paid.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    230 views3 pages

    Bull Call Spread

    Uploaded by

    pkkothari
    This strategy involves buying one call option and selling another call option at a higher strike price to help pay for the cost of the long call. If the stock price increases but stays below the higher strike price, the spread profits similar to a regular long call. However, if the stock rises above the higher strike price, gains are capped. The maximum profit is limited and defined as the difference between the strike prices minus the debit paid. The maximum loss is limited to the initial debit paid.

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    At a glance
    Powered by AI
    A bull call spread is a limited risk, limited reward vertical spread strategy that can profit from a rise in the underlying asset's price up to a maximum level. It involves being long one call and short another call with a higher strike to help offset the cost of the long call.

    If held into expiration, there is risk that the short call may be assigned, requiring the investor to sell shares, or it may not be assigned, leaving the investor with an unwanted long stock position. The investor must be prepared for either outcome and monitor the stock closely leading up to expiration.

    The passage of time hurts the strategy's profitability as expiration approaches. Volatility and the movement of the underlying asset's price can also impact whether both calls increase or decrease in value together as expected. The difference between the strikes and the net premium paid set the maximum profit and loss levels.

    Equity Options

    Strategy

    MONTRÉAL EXCHANGE

    Bull Call Spread


    Bear Put Spread

    (Debit Call Spread)

    Description
    A bull call spread is a type of vertical spread. It contains two calls with the same expiration but different strikes.
    The strike price of the short call is higher than the strike of the long call, which means this strategy will always
    require an initial outlay (debit). The short call’s main purpose is to help pay for the long call’s upfront cost.

    Up to a certain stock price, the bull call spread works a lot like its long call component would as a standalone
    strategy. However, unlike with a plain long call, the upside potential is capped. That is part of the tradeoff; the
    short call premium mitigates the overall cost of the strategy but also sets a ceiling on the profits.

    A different pair of strike prices might work, provided that the short call strike is above the long call’s. The choice is
    a matter of balancing risk/reward tradeoffs and a realistic forecast.

    Bull Call Spread Example


    Net Position
    + Long 1 XYZ 60 call
    Short 1 XYZ 65 call

    MAXIMUN GAIN
    High strike - low strike - net premium paid
    0
    50 55 60 65 70
    MAXIMUN LOSS
    Net premium paid

    The benefit of a higher short call strike is a higher maximum to the strategy’s potential profit. The disadvantage is
    that the premium received is smaller, the higher the short call’s strike price.

    It is interesting to compare this strategy to the bull put spread. The profit/loss payoff profiles are exactly the same,
    once adjusted for the net cost to carry. The chief difference is the timing of the cash flows. The bull call spread
    requires a known initial outlay for an unknown eventual return; the bull put spread produces a known initial cash
    inflow in exchange for a possible outlay later on.
    Outlook
    Looking for a steady or rising stock price during the life of the options. As with any limited-time strategy, the
    investor’s long-term forecast for the underlying stock isn’t as important, but this is probably not a suitable choice
    for those who have a bullish outlook past the immediate future. It would require an accurately timed forecast to
    pinpoint the turning point where a coming short-term dip will turn around and a long-term rally will start.

    Summary
    This strategy consists of buying one call option and selling another at a higher strike price to help pay the cost.
    The spread generally profits if the stock price moves higher, just as a regular long call strategy would, up to the
    point where the short call caps further gains.

    Motivation
    Profit from a gain in the underlying stock’s price without the up-front capital outlay and downside risk of outright
    stock ownership.

    Variations
    A vertical call spread can be a bullish or bearish strategy, depending on how the strike prices are selected for the
    long and short positions. See bear call spread for the bearish counterpart.

    Max Loss
    The maximum loss is very limited. The worst that can happen is for the stock to be below the lower strike price at
    expiration. In that case, both call options expire worthless, and the loss incurred is simply the initial outlay for the
    position (the net debit).

    Max Gain
    The maximum gain is capped at expiration, should the stock price do even better than hoped and exceed the
    higher strike price. If the stock price is at or above the higher (short call) strike at expiration, in theory, the
    investor would exercise the long call component and presumably would be assigned on the short call. As a result,
    the stock is bought at the lower (long call strike) price and simultaneously sold at the higher (short call strike)
    price. The maximum profit then is the difference between the two strike prices, less the initial outlay (the debit)
    paid to establish the spread.

    Profit/Loss
    Both the potential profit and loss for this strategy are very limited and very well-defined: the net premium paid at
    the outset establishes the maximum risk, and the short call strike price sets the upper boundary beyond which
    further stock gains won’t improve the profitability. The maximum profit is limited to the difference between the
    strike prices, less the debit paid to put on the position.

    Breakeven
    This strategy breaks even at expiration if the stock price is above the lower strike by the amount of the initial
    outlay (the debit). In that case, the short call would expire worthless and the long call’s intrinsic value would equal
    the debit.

    Breakeven = long call strike + net debit paid

    2
    Volatility
    Slight, all other things being equal. Since the strategy involves being long one call and short another with the
    same expiration, the effects of volatility shifts on the two contracts may offset each other to a large degree.

    Note, however, that the stock price can move in such a way that a volatility change would affect one price more
    than the other.

    Time Decay
    The passage of time hurts the position, though not as much as it does a plain long call position. Since the strategy
    involves being long one call and short another with the same expiration, the effects of time decay on the two
    contracts may offset each other to a large degree.

    Regardless of the theoretical price impact of time erosion on the two contracts, it makes sense to think the
    passage of time would be somewhat of a negative. This strategy requires a non-refundable initial investment. If
    there are to be any returns on the investment, they must be realized by expiration. As expiration nears, so does
    the deadline for achieving any profits.

    Assignment Risk
    Early assignment, while possible at any time, generally occurs only when the stock goes ex-dividend. Be warned,
    however, that using the long call to cover the short call assignment will require establishing a short stock position
    for one business day, due to the delay in assignment notification.

    And be aware, any situation where a stock is involved in a restructuring or capitalization event, such as a merger,
    takeover, spin-off or special dividend, could completely upset typical expectations regarding early exercise of
    options on the stock.

    Expiration Risk
    Yes. If held into expiration this strategy entails added risk. The investor cannot know for sure until the following
    Monday whether or not the short call was assigned. The problem is most acute if the stock is trading just below, at
    or just above the short call strike.

    Assume that the long call is in-the-money and that the short call is roughly at-the-money. Exercise (stock
    purchase) is certain, but assignment (stock sale) isn’t. If the investor guesses wrong, the new position on Monday
    will be wrong, too. Say, assignment is expected but fails to occur; the investor will unexpectedly be long the stock
    on the following Monday, subject to an adverse move in the stock over the weekend. Now assume the investor bet
    against assignment and sold the stock in the market instead; come Monday, if assignment occurred, the investor
    has sold the same shares twice for a net short stock position, and is exposed to a rally in the stock price.

    Two ways to prepare: close the spread out early or be prepared for either outcome on Monday. Either way, it’s
    important to monitor the stock, especially over the last day of trading.

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