What Is Bull Spread? How It Works as Trading Strategy and Example

There is no free lunch when it comes to options trading, and the bull call spread is no exception. The spread does come with some disadvantages as well that should be carefully considered. The biggest disadvantage of a bull call spread is the effects of time decay, known in the options world as “theta.”, one of the Options Greeks.

Successful trading isn’t just about soaring profits but also mastering the art of risk mitigation. This strategy essentially combines selling an at-the-money straddle and buying protective “wings.” You can also think of the construction as two spreads. The long, out-of-the-money put protects against downside (from the short put strike to zero). Profit and loss are both limited within a specific range, depending on the strike prices of the options used. Investors like this strategy for the income it generates and the higher probability of a small gain with a non-volatile stock.

How Does the Underlying Asset Affect a Bull Call Spread’s Premium?

A box is an options strategy that creates a synthetic loan by going long a bull call spread along with a matching bear put spread using the same strike prices. The result will be a position that always pays off the distance between the strikes at expiration. So if you put on a 20-strike, 40-strike box, it will always expire worth $20. Prior to expiration, it will be worth less than $20, making it function like a zero-coupon bond. Traders use boxes to borrow or lend funds for money management purposes depending on the implied interest rate of the box. In the P&L graph above, notice how the maximum gain is made when the stock remains unchanged up until expiration–at the point of the ATM strike.

Price risk is the primary risk with the trade as a sharp drop in the underlying stock will hurt the trade. Vega is the greek that measures a position’s exposure to changes in implied volatility. If a position has negative vega overall, it will benefit from falling volatility. As a result, both options expire in-the-money bull call spread strategy with the 50 call having an intrinsic value of $800 while the 56 call has an intrinsic value of $200. So the stock would need to rise to $52 by the expiration date for the trade to break even. Also, see our guide to understanding the basics of reading candlestick charts and option trading strategies.

Pros of the Strategy

American options can be more expensive than European options because of this added flexibility. For one, you can’t be absolutely certain that the buyer of the https://www.bigshotrading.info/ short option will not exercise against you. In case the buyer exercises their call option, you would have to make good on it and come up with the shares.

• In this example, the trader would not gain any more profit once the stock moved past $55.
• You can benefit from this strategy by buying a Call with a Strike price of 10,300 at a premium of 170 and selling a Call option with a strike price 10,700 at a premium of Rs 60.
• The strategy entails the buying and selling of either a call or put with different strike prices but with the same expiration date on the same underlying security or asset at the same time.
• If your bull call spread reaches expiration, the resulting scenario hinges on the stock’s closing price.

An investor may choose to use this strategy as a way of protecting their downside risk when holding a stock. This strategy functions similarly to an insurance policy; it establishes a price floor in the event the stock’s price falls sharply. When a Bull Call Spread is purchased, the trader instantly knows the maximum amount of money they can possibly lose and the maximum amount of money they can make. The net effect of this transaction is that the trader has paid out $42 ($60 paid – $18 received).

Bull call spread

The bull call spread is a limited risk and highly versatile position that can be utilized by even novice traders. The spread can potentially provide significant profit potential with little stress. With its numerous advantages, the bull call spread should be a part of every trader’s arsenal. One adjustment could be to buy back the short leg of the spread if the market is moving favorably. Although this will increase the capital risk on the trade, the total risk is still defined. Buying back the short leg will, however, turn the position into one with unlimited profit potential.