Bull Call Spread Strategy Explained (A Simple Guide)
How would you like to make a very nice return on a stock that you think will go up moderately in the short term? If so, then consider a bull call spread strategy.
When you enter into a bull call spread, you’re opening both a long and short position on a call option at different strike prices for the same expiration date. The strike price for the short call is higher, so there will be an initial cash outlay on your part.
However, that initial cash outlay is the maximum that you’ll lose.
The short call limits your profit while simultaneously making the cost of the long call cheaper.
In this article, I’ll go over the bull call spread in detail so you can determine if it has any place in your trading strategies.
What Is a Bull Call Spread?
A bull call spread is a type of vertical spread in options trading.
If you’re unfamiliar with the concept of a vertical spread, it involves buying and selling two of the same types of options at different strike prices with the same expiration date.
Let’s say that Merck is currently trading at $75 per share. If you buy a $74 call option at $2.04 and sell a $76 call option at $1 for the same expiration date, you’ve just entered into a vertical spread.
In fact, you’ve just entered into a bull call spread.
The money you earn from selling the call at the higher strike price lowers your total cash outlay. So you really only spend $1.04 ($2.04 – $1) for the whole transaction.
Read Also: What is a horizontal spread?
When Would You Use a Bull Call Spread?
Use a bull call spread when you think a stock price is going to go up modestly over the short term.
There’s quite a bit in that sentence so let’s unpack it.
First, you need to believe that the stock will go up in value. If the stock goes down in value, you’ll lose money.
In other words, this is not a strategy for people who are bearish on the underlying stock.
Second, you want it to go up in value over the short term. You’ll make money when the price of the stock appreciates heading into contract expiration. If it stays the same or drops, you’ll likely close out the position for a loss.
Finally, you only want the stock to go up moderately. That’s because the bull call spread limits your profits.
If the stock skyrockets in value, you’ll still make money but your profit will be limited.
How Does a Bull Call Spread Work?
A bull call spread involves a multi-leg options order. In this case, that means you’ll buy and sell options at the same time.
It’s important to make sure that your trading platform supports multi-leg orders before you enter into a bull call spread.
Start by purchasing an in-the-money call for a stock that you think will rise in value in the near term.
Then, sell an out-of-the-money call for that same stock at a higher strike price.
Remember: use the same expiration date for both options.
You’ll pay for the purchase of the long call. However, you’ll generate some quick cash with the sale of the call at the higher strike price.
That additional cash will reduce the amount of your investment. As a result, you can invest in a long call for a lower price than if you just purchased the call outright.
Of course, that short sale will also limit your profits. If the stock goes well past the higher strike price before contract expiration, you won’t enjoy any of those additional profits.
Still, you will make money. In some cases, you can enjoy a significant return over the short term.
Real Life Example Using a Bull Call Spread?
Let’s say that Pfizer is currently trading at $43.60. You think it’s going to go up a few points in the short term so you decide to open a bull call spread.
You start by purchasing a $43.50 call for $1.07. Remember, though, that means you pay $107 ($1.07 x 100) for that position because options contracts are offered in groups of 100 shares.
Next, you sell the $45 call for $0.42. That will earn you $42 ($0.42 x 100).
So the total cash outlay for the position is $107 – $42 or $65.
Now suppose that Pfizer goes up to $46 per share at contract expiration. That means your long call is worth $250 ($2.50 x 100). Your short call is worth $100 ($1.00 x 100).
To close out the transaction, you’ll have to simultaneously sell the long call while buying to close the short call. That means you’ll earn $250 from the sale of the long call while spending $100 to close the short call.
So you end up with $150 ($250 – $100) after the transaction.
Since your initial investment was $65, you earned a whopping 130% return on the investment. And that’s over a short term.
On the other hand, if Pfizer shares dropped down to $40, all of your options would expire worthless and you’d be out the whole $65 for a 100% loss.
What Are Similar Strategies Related to Bull Call Spread?
Here are a few strategies similar to the bull call spread:
- Collar Strategy – Involves buying protective puts and selling call options against shares of stock that you own.
- Costless Collar Strategy – The same thing as a collar strategy except that the sale of the options earns you exactly as much money as it costs to buy the protective puts. In other words, it doesn’t cost anything.
- Bull Put Spread – Involves buying one out-of-the-money put option while selling an in-the-money put option.
Bull Call Spread Compared to Other Options Strategies?
A bull call spread is a limited-risk, limited return options strategy.
Keep in mind: in this case, “limited risk” means that you can lose 100% of your investment. Experienced options traders understand that and accept it because options typically trade at much lower prices than stocks.
Also, there are other options strategies that can give you a loss well in excess of 100%. If all you do is short a call, for example, your potential loss is infinite.
Advantages & Risks of Bull Call Spread?
- Lower cost long call – If you’re bullish on a stock, a bull call spread is a great way to buy a long call at a lower price. That’s because the sale of the short call offsets the amount of money you spend on the long call.
- Healthy returns – Because you’re investing in options, you have leverage. As a result, you can enjoy some very nice returns within a 30-60 day time period.
- Limited profit – Because you’ve got a short position on the higher strike price, your profit is limited. You won’t be able to capitalize on a stock that shoots up in value during the contract period.
- You can still take a loss – Investments always carry some risk. A bull call spread is no exception. You could possibly lose all the money you invest in the position.