Bull Spread
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Bull Spread
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An options strategy that involves purchasing an in-the-money (ITM) call option and selling an out-of-the-money (OTM) call option with a higher strike price
A bull call spread, which is an options strategy, is utilized by an investor when he believes a stock will exhibit a moderate increase in price. A bull spread involves purchasing an in-the-money (ITM) call option and selling an out-of-the-money (OTM) call option with a higher strike price but with the same underlying asset and expiration date. A bull call spread should only be used when the market is exhibiting an upward trend.
To determine the maximum profit, maximum loss, and break-even point for a bull call spread, refer to the following formulas:
An investor utilizes a bull call spread by purchasing a call option for a premium of $10. The call option comes with a strike price of $50 and expires in July 2020. At the same time, the investor sells a call option for a premium of $3. The call option comes with a strike price of $70 and expires in July 2020. The underlying asset is the same and is currently trading at $50. Summarizing the information above:
In writing the two options, the investor witnessed a cash outflow of $10 from purchasing a call option and a cash inflow of $3 from selling a call option. Netting the amounts together, the investor sees an initial cash outflow of $7 from the two call options.
Now, assume that it is July 2020. The table below illustrates theoretical stock prices at the expiration date.
At a price of $60 or above, the investor’s gain is capped at $3 because both the long call option and short call option is in-the-money. For example, at the stock price of $65:
Factoring in net commissions , the investor would be left with a net gain of $3 .
At a price of $50 or below, the investor’s loss is capped at -$7, because both the long call option and short call option are out-of-the-money. For example, at the stock price of $45:
Factoring in net commissions, the investor would be left with a net loss of $7 .
Therefore, in a bull call spread, the investor is:
Applying the formulas for a bull call spread:
The values correspond to the table above.
The comprehensive example above can be visually represented as follows:
Note that the blue line is simply a combination of the two dotted yellow lines.
The payout table below corresponds to the visual graph above.
Jorge is looking to utilize a bull call spread on ABC Company. ABC Company is currently trading at a price of $150. He purchases an in-the-money call option for a premium of $10. The strike price for the option is $145 and expires in January 2020. Additionally, Jorge sells an out-of-the-money call option for a premium of $2. The strike price for the option is $180 and expires in January 2020.
What are the maximum payout, maximum loss, and break-even point of the bull call spread above?
The net commission is $8 ($2 OTM Call – $10 ITM Call).
Applying the formulas for a bull call spread, Jorge determines the:
To confirm, Jorge creates a payout table:
The primary benefit of using a bull call spread is that it costs lower than buying a call option. In the example above, if Jorge only used a call option, he would need to pay a $10 premium. Through using a bull call spread, he only needs to pay a net of $8. In addition to being cheaper, the losses are lower as well. If the stock dropped to $0, Jorge would only realize a loss of $8 versus $10 (if he were to just use a long call option).
However, one significant drawback from using a bull call spread is that potential gains are limited. For example, in the example above, the maximum gain Jorge can realize is only $27 due to the short call option position. Even if the stock price were to skyrocket to $500, Jorge would only be able to realize a gain of $27.
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A bull call spread is an options strategy used when a trader is betting that a stock will have a limited increase in its price. The strategy uses two call options to create a range consisting of a lower strike price and an upper strike price. The bullish call spread can limit the losses of owning stock, but it also caps the gains.
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A bull spread is a bullish options strategy using either two puts, or two calls with the same underlying asset and expiration.
Butterfly spread is an options strategy combining bull and bear spreads, involving either four calls and/or puts, with fixed risk and capped profit.
Options are financial derivatives that give the buyer the right to buy or sell the underlying asset at a stated price within a specified period.
An iron condor involves buying and selling calls and puts with different strike prices when a trader expects low volatility.
A collar, commonly known as a hedge wrapper, is an options strategy implemented to protect against large losses, but it also limits large gains.
An outright option is an option that is bought or sold individually and is not part of a multi-leg options trade.
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James Chen, CMT is an expert trader, investment adviser, and global market strategist. He has authored books on technical analysis and foreign exchange trading published by John Wiley and Sons and served as a guest expert on CNBC, BloombergTV, Forbes, and Reuters among other financial media.
A bull call spread is an options trading strategy designed to benefit from a stock's limited increase in price. The strategy uses two call options to create a range consisting of a lower strike price and an upper strike price. The bullish call spread helps to limit losses of owning stock, but it also caps the gains.
The bull call spread consists of the following steps involving two call options.
The premium received by selling the call option partially offsets the premium the investor paid for buying the call. In practice, investor debt is the net difference between the two call options, which is the cost of the strategy.
The bull call spread reduces the cost of the call option, but it comes with a trade-off. The gains in the stock's price are also capped, creating a limited range where the investor can make a profit. Traders will use the bull call spread if they believe an asset will moderately rise in value. Most often, during times of high volatility, they will use this strategy.
The losses and gains from the bull call spread are limited due to the lower and upper strike prices. If at expiry, the stock price declines below the lower strike price—the first, purchased call option—the investor does not exercise the option. The option strategy expires worthlessly, and the investor loses the net premium paid at the onset. If they exercise the option, they would have to pay more—the selected strike price—for an asset that is currently trading for less.
If at expiry, the stock price has risen and is trading above the upper strike price—the second, sold call option—the investor exercises their first option with the lower strike price. Now, they may purchase the shares for less than the current market value.
However, the second, sold call option is still active. The options marketplace will automatically exercise or assign this call option. The investor will sell the shares bought with the first, lower strike option for the higher, second strike price. As a result, the gains earned from buying with the first call option are capped at the strike price of the sold option. The profit is the difference between the lower strike price and upper strike price minus, of course, the net cost or premium paid at the onset.
With a bull call spread, the losses are limited reducing the risk involved since the investor can only lose the net cost to create the spread. However, the downside to the strategy is that the gains are limited as well.
Investors can realize limited gains from an upward move in a stock's price
A bull call spread is cheaper than buying an individual call option by itself
The bullish call spread limits the maximum loss of owning a stock to the net cost of the strategy
The investor forfeits any gains in the stock's price above the strike of the sold call option
Gains are limited given the net cost of the premiums for the two call options
Commodities, bonds, stocks, currencies, and other assets form the underlying holdings for call options. Call options can be used by investors to benefit from upward moves in an asset's price. If exercised before the expiration date, these options allow the investor to buy the asset at a stated price—the strike price . The option does not require the holder to purchase the asset if they choose not to. For example, traders who believe a particular stock is favorable for an upward price movement will use call options.
The bullish investor would pay an upfront fee—the premium —for the call option. Premiums base their price on the spread between the stock's current market price and the strike price. If the option's strike price is near the stock's current market price, the premium will likely be expensive. The strike price is the price at which the option gets converted to the stock at expiry.
Should the underlying asset fall to less than the strike price, the holder will not buy the stock but will lose the value of the premium at expiration. If the share price moves above the strike price the holder may decide to purchase shares at that price but are under no obligation to do so. Again, in this scenario, the holder would be out the price of the premium.
An expensive premium might make a call option not worth buying since the stock's price would have to move significantly higher to offset the premium paid. Called the break-even point (BEP) , this is the price equal to the strike price plus the premium fee.
The broker will charge a fee for placing an options trade and this expense factors into the overall cost of the trade. Also, options contracts are priced by lots of 100 shares. So, buying one contract equates to 100 shares of the underlying asset.
A bull call spread can limit your losses, but also caps your gains.
An options trader buys 1 Citigroup ( C ) June 21 call at the $50 strike price and pays $2 per contract when Citigroup is trading at $49 per share.
At the same time, the trader sells 1 Citi June 21 call at the $60 strike price and receives $1 per contract. Because the trader paid $2 and received $1, the trader’s net cost to create the spread is $1.00 per contract or $100. ($2 long call premium minus $1 short call profit = $1 multiplied by 100 contract size = $100 net cost plus, your broker's commission fee)
If the stock falls below $50, both options expire worthlessly, and the trader loses the premium paid of $100 or the net cost of $1 per contract.
Should the stock increase to $61, the value of the $50 call would rise to $10, and the value of the $60 call would remain at $1. However, any further gains in the $50 call are forfeited, and the trader’s profit on the two call options would be $9 ($10 gain - $1 net cost). The total profit would be $900 (or $9 x 100 shares).
To put it another way, if the stock fell to $30, the maximum loss would be only $1.00, but if the stock soared to $100, the maximum gain would be $9 for the strategy.
To implement a bull call spread involves choosing the asset that is likely to experience a slight appreciation over a set period of time (days, weeks, or months). The next step is to buy a call option for a strike price above the current market with a specific expiration date while simultaneously selling a call option at a higher strike price that has the same expiration date as the first call option. The net difference between the premium received for selling the call and the premium paid for buying the call is the cost of the strategy.
With a bull call spread, the losses are limited, reducing the risk involved, since the investor can only lose the net cost to create the spread. The net cost is also lower as the premium collected from selling the call helps to defray the cost of the premium paid to buy the call. Traders will use the bull call spread if they believe an asset will rise in value just enough to justify exercising the long call but not enough to where the short call can be exercised.
Since the bull call spread is implemented on the premise of a modest appreciation in the underlying asset's price, it stands to reason that its premium will mirror that of the asset's price, up to a certain point. Essentially, a bull call spread's delta, which compares the change in the underlying asset's price to the change in the option's premium, is net positive. However, its gamma, which measures the rate of change of delta, is very close to zero which means that there is very little change in the bull call spread's premiums as the underlying asset's price changes.
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An options strategy that involves purchasing out-of-the-money (OTM) put option and selling an in-the-money (ITM) put option with a higher strike price
A bull put spread, which is an options strategy, is utilized by an investor when he believes the underlying stock will exhibit a moderate increase in price. A bull put spread involves purchasing an out-of-the-money (OTM) put option and selling an in-the-money (ITM) put option with a higher strike price but with the same underlying asset and expiration date. A bull put spread should only be used when the market is exhibiting an upward trend.
To determine the maximum loss and break-even point for a bull put spread, refer to the following formulas:
Note that when the bull put spread position is entered, the investor starts with the maximum gain and faces potential losses as the strategy approaches maturity. Following, we will go through a comprehensive example outlining this.
An investor utilizes a bull put spread by purchasing a put option for a premium of $15. The put option comes with a strike price of $80 and expires in July 2020. At the same time, the investor sells a put option for a premium of $35. The put option comes with a strike price of $120 and expires in July 2020. The underlying asset is the same and is currently trading at $95.
In writing the two options, the investor witnessed a cash outflow of $15 from purchasing a call option and a cash inflow of $35 from selling a call option. Netting the amounts together, the investor generated an initial cash inflow of $20 from the two put options.
Now, assume that it is July 2020. The table below illustrates theoretical stock prices at the expiration date.
At a price of $120 or above, the investor’s gain is capped at $20 because both the long put option and the short put option are out-of-the-money. For example, at the stock price of $125:
Factoring in net commissions , the investor would be left with a net gain of $20.
At a price of $80 or below, the investor’s loss is capped at -$20 because both the long put option and the short put option are in-the-money. For example, at the stock price of $75:
Factoring in net commissions, the investor would be left with a net loss of $20 .
Therefore, in a bull put spread, the investor is:
Applying the formulas for a bull put spread:
The values calculated correspond to the table above.
The comprehensive example above can be visually represented as follows:
Note that the blue line is simply a combination of the two dotted yellow lines.
The payout table below corresponds to the visual graph above.
Jorge is looking to utilize a bull put spread on ABC Company. ABC Company is currently trading at a price of $150. He purchases an in-the-money put option for a premium of $10. The strike price for this option is $140 and expires in January 2020. Additionally, Jorge sells an out-of-the-money put option for a premium of $30. The strike price for the option is $180 and expires in January 2020.
What are the maximum payout, maximum loss, and break-even point of the bull call spread above?
The net commissions is $20 ($30 OTM Put – $10 ITM Put).
Applying the formulas for a bull call spread, Jorge determines:
To confirm, Jorge creates a payout table:
The main reason behind using a bull put spread is to immediately realize the maximum profit upon executing the spread. In the example above, Jorge is able to realize a maximum profit of $20 immediately into executing a bull put spread. In addition, although the maximum gains are capped, the investor is protected from downside risk as well.
However, one significant drawback from a bull put spread is that potential gains are limited. For example, in the example above, the maximum gain Jorge can realize is only $20 due to the short put option position. Even if the stock price were to decline to $0, Jorge would only be able to realize a gain of $20.
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